Scientific 
Auditing 


R.H. 
SPEAR 


PUBLISHED  BY 

COMMERCIAL  WORLD  PUBLISHING  COMPANY 
DETROIT,  MICHIGAN,  U.  S.  A. 


Copyright,  1912 
By  R.  H.  SPEAR 

Detroit,  Michigan 
All  Rights  Reserved 


AUDITING. 

During  the  past  two  decades  so  many  volumes  have  been 
written  upon  the  subjects  of  bookkeeping,  accounting,  auditing, 
cost  accounting  and  systematizing  that  it  might  seem  difficult  for 
any  one  to  undertake  the  successful  authorship  of  a  new  volume 
complete  with  up-to-date  ideas  and  suggestions.  To  a  certain 
extent  this  would  be  true  if  it  was  not  for  the  fact  that  during 
this  period  a  remarkable  change  has  been  made  in  all  lines  of 
commercial  endeavor.  Such  marvelous  improvements  have  been 
effected  as  to  require  a  corresponding  development  in  the  science  of 
accounting  and  auditing,  to  meet  present  day  needs.  Systems  of 
accounting  or  methods  of  auditing  employed  with  the  highest  degree 
of  efficiency  twenty  or  even  ten  years  ago  prove  wholly  inadequate 
for  present  use. 

Prior  to  entering  upon  a  discussion  of  that  particular  branch  of 
the  science  of  accounting  known  as  "Auditing,"  it  is  considered 
advisable  to  comprehensively  define  the  position  of  the  bookkeeper, 
accountant,  auditor,  cost  accountant  and  systematizer  in  the  affairs 
of  the  commercial  world  and  their  co-relation,  which  is  similar  to 
the  corresponding  relations  of  bookkeeping,  accounting,  auditing, 
cost  accounting  and  systematizing. 

THE  BOOKKEEPER. 

A  person  who  keeps  the  accounts  of  another  person,  partner- 
ship or  corporation.  An  officer  who  has  charge  of  keeping  the 
books  and  accounts  in  a  public  office  is  also  designated  as  a 
bookkeeper. 

The  duties  of  a  bookkeeper  consist  in  keeping  an  accurate  record 
of  the  business  transactions  of  the  party  by  whom  he  is  employed, 
prepare  statements  from  time  to  time  to  show  the  condition  of 
affairs  of  the  business  and  provide  such  other  information  as  is 
required.  He  should  be  always  on  the  alert  to  make  note  of  any 
suggestions  or  ideas  for  formulating  plans  for  improving  the  stand- 
ard of  the  work,  so  that  he  will  accomplish  more  with  less  labor, 
and  produce  better  results. 

In  assuming  the  responsibility  of  a  new  position  the  book- 
keeper is  not  expected  to  immediately  verify  the  entire  accounting 
records  as  he  finds  them,  but,  by  all  means,  should  verify  the  cash 

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on  hand,  reconcile  the  bank  account,  and  take  a  trial  balance  to 
ascertain  the  equilibrium  of  the  ledger  accounts.  Any  differences 
are  noted  and  called  to  the  attention  of  his  employer,  so  that  he  is 
not  held  responsible  for  any  shortages  which  are  discovered  later. 
He  should  devote  his  best  efforts  towards  improving  the  system 
of  accounting  in  use  and  perfecting  any  ideas  which  he  possesses 
for  simplifying  the  work.  A  bookkeeper  has  no  difficulty  in  pro- 
viding a  check  upon  the  accuracy  of  his  own  work,  as  it  is  a  very 
simple  matter  for  him  to  establish  memorandum  accounts  to  which 
he  makes  postings  corresponding  with  the  postings  made  to  the 
ledgers.  If  he  is  operating  a  system  of  sectionalized  ledgers  it  is 
unnecessary  that  he  should  have  the  entries  to  the  private  ledger 
or  balances  of  the  controlling  accounts  therein  in  order  to  deter- 
mine the  accuracy  of  his  work. 

THE  ACCOUNTANT. 

An  individual  who  is  today  looked  upon  by  business  men  as  a 
person  having  exceptional  analytical  powers,  and  whose  duty  it  is 
to  certify  as  to  the  correctness  and  exactness  of  transactions 
recorded  upon  the  books  of  record. 

He  is  further  expected  to  examine  the  distribution  of  charges 
and  to  devise  special  accounting  systems  to  meet  special  require- 
ments in  order  that  the  bookkeeping  or  accounting  work  may  be 
accomplished  in  the  shortest  possible  time  with  a  minimum  of  labor. 

The  accountant  should  be  qualified  to  pass  expert  opinion  upon 
any  matters  in  the  science  of  accounting  in  any  line  of  business, 
no  matter  what  system  is  used.  His  examination  of  the  accounts 
should  show  any  losses  sustained,  the  particular  department  of  the 
business  in  which  they  are  occurring,  and  to  suggest  special  methods 
or  systems  to  prevent  such  losses,  or  to  increase  the  profits  of  any 
department.  .He  should  be  thoroughly  familiar  with  banking  and 
financial  methods,  so  that  in  outlining  a  system  the  minimum 
amount  of  capital  will  bring  the  best  profits  in  order  that  the  funds 
may  be  invested  and  reinvested  as  frequently  as  possible. 

The  professional  or  business  man  looks  upon  the  accountant 
as  an  unquestioned  authority  in  the  science  of  accounting,  and 
frequently  thousands  of  dollars  are  invested  upon  his  recommenda- 
tion as  to  the  financial  condition  of  the  business  and  the  soundness 
of  his  knowledge  of  business  affairs. 

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A  careful  distinction  is  made  between  the  public  accountant 
and  specialists.  This  is  the  age  of  the  specialist,  and  owing  to  the 
many  and  rapid  improvements  in  the  science  of  accounting  public 
accountants  are  beginning  to  train  themselves  for  some  particular 
branch  of  the  science. 

THE  AUDITOR. 

A  person  appointed  and  authorized  to  examine  an  account  or 
accounts,  compare  the  charges  with  the  vouchers,  carefully  check 
all  receipts,  etc. ;  briefly  stated,  a  person  appointed  and  authorized 
to  examine  the  affairs  of  a  business  for  any  specified  period,  to 
ascertain  its  true  financial  condition. 

The  auditor's  investigation  does  not  cease  with  merely  checking 
the  figures  on  the  books  of  account,  but  includes  an  examination  of 
the  nature  and  substance  of  the  various  accounts  to  ascertain  the 
correctness  of  the  various  charges  as  stated.  The  duties  of  the 
auditor,  however,  are  governed  largely  by  the  circumstances  under 
which  he  is  appointed. 

Auditors  are  of  several  different  classes  or  kinds,  and  their  gen- 
eral competency  usually  designates  the  particular  class  to  which 
they  belong.  During  the  experience  of  the  editor  he  has  had  oppor- 
tunity to  examine  the  work  of  various  auditors,  some  of  whom,  he 
is  sorry  to  state,  were  wholly  incompetent  to  perform  the  respon- 
sibilities entrusted  to  them. 

The  duties  of  the  auditor  represent  an  important  responsibility 
as  the  investment  of  thousands  of  dollars  sometimes  is  made  upon 
his  certified  statement  as  to  the  financial  condition  of  a  business. 
It  may  be  well  to  state  the  possible  result  from  the  investment  of  a 
large  amount  of  money  upon  an  auditor's  investigation  and  certifica- 
tion when  he  is  unqualified  for  the  undertaking;  the  loss  of  not 
only  the  greater  part  of  the  investment,  but  the  downfall  of  a  busi- 
ness giving  employment  to  scores  of  individuals.  The  auditors  in 
this  class  are  usually  conscientious,  but  after  failing  to  justify  the 
confidence  reposed  in  them,  they  lose  their  foothold  in  the  science 
and  art  and  are  reduced  to  their  proper  level. 

Another  class  of  auditors  is  found,  thoroughly  efficient  in  every 
detail,  who  usually  employ  a  staff  of  trained  assistants  that  enables 
them  to  undertake  audits  that  it  would  be  impossible  for  any  one 
man  to  perform.  The  result  of  an  audit  conducted  by  a  represent- 

5 


ative  of  this  class  usually  can  be  depended  upon  as  being  thorough 
and  complete,  although  there  are  certain  instances  where  the  work 
is  entrusted  solely  to  trained  assistants  who  do  not  possess  the 
excellent  qualifications  held  by  the  auditor  proprietor. 

A  third  class  of  auditors  of  exceptional  competency  is  found 
who  are  usually  engaged  to  audit  the  accounts  of  states  and  munici- 
palities, or  who  are  appointed  by  the  courts  to  investigate  estates, 
although  appointees  for  this  latter  purpose  are  invariably  lawyers 
possessing  a  practical  knowledge  of  auditing,  the  science  of  accounts, 
and  law. 

Another  set  of  auditors  are  found  in  this  third  class,  namely, 
employes  of  national  and  state  departments  who  secure  their  posi- 
tions through  political  influence,  but  upon  whom  devolves  important 
responsibilities  properly  belonging  to  the  work  that  should  be  per- 
formed by  the  auditor  for  states  and  municipalities. 

From  close  observation,  it  would  seem  that  appointments  thus 
made  usually  result  in  certain  reforms  or  the  installation  of  different 
systems  of  accounting,  which  is  usually  not  entrusted  to  the  em- 
ployee. In  the  installation  of  a  complete  accounting  system  for  any 
department  of  a  municipality  or  its  various  departments,  the  ser- 
vices of  public  accountants  of  prominence  usually  are  sought,  in 
order  that  the  system  installed  may  be  effective  and  work  to  the 
advantage  of  all  conditions.  Briefly  stated,  the  auditors  described 
come  under  the  following  classifications: 

First — The  auditor  who  is  unqualified  and  incompetent,  but  who 
accepts  the  responsibilities  when  he  knows  that  he  cannot  justify 
the  confidence  reposed  in  him. 

Second — The  auditor  who  employs  a  corps  of  trained  assistants 
to  assist  him  in  large  undertakings,  but  sometimes  entrusts  too 
great  responsibility  to  his  employees  without  giving  proper  atten- 
tion to  the  work  himself. 

Third — Auditors  for  states  or  municipalities;  auditors  appointed 
by  courts  for  various  estates  to  investigate  and  pass  upon  the  ac- 
counts of  estates ;  invariably  lawyers.  Employes  of  national  and 
state  departments  entrusted  with  the  responsibilities  of  an  auditor, 
the  national  and  state  bank  examiners,  insurance  examiners  and 
examiners  connected  with  the  Bureau  of  Corporations  of  the  depart- 
ment of  Commerce  and  Labor,  although  this  title  is  given  to  some 
individuals  who  act  in  their  official  capacity  as  auditors. 

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THE  COST  ACCOUNTANT. 

A  person  entrusted  with  the  responsibility  of  accurately -deter- 
mining the  cost  of  production  of  an  article.  The  successful  per- 
formance of  his  duties  requires  a  full  knowledge  of  all  of  the  sub- 
jects involved  in  the  science  of  cost  accounting. 

THE  SYSTEMATIZER. 

A  person  entrusted  with  the  responsibility  of  a  business  or  fac- 
tory organization,  evolving  systems  and  methods  the  operation  and 
execution  of  which  have  a  tendency  to  increased  plant  efficiency  at 
no  increased  cost,  and  with  a  probable  saving  of  money  by  the 
reduction  of  labor  or  other  expenditure. 

This  brief  synopsis  of  the  duties  of  the  individuals  entrusted 
with  the  responsibility  of  recording  business  transactions,  studying 
commercial  conditions  with  a  view  to  increased  accuracy  or  effici- 
ency in  making  such  records,  the  verification  of  the  books  of  record 
and  comparative  statistical  statements  compiled  therefrom,  the 
determining  of  accurate  costs  of  production  and  a  systematic  organ- 
ization of  any  factory  or  business  has  a  tendency  to  point  out  clearly 
the  position  occupied  by  the  auditor  in  the  execution  of  his  duties. 

AN  AUDIT  ESSENTIAL. 

There  are  several  reasons  why  the  books  of  any  business, 
whether  single  proprietorship,  partnership,  society  or  corporation 
should  be  audited  under  a  continuous  or  periodical  audit.  Perhaps 
the  most  important  reason  is  readily  made  apparent  by  a  consider- 
ation of  the  methods  used  by  a  great  many  business  houses  or  the 
efficiency  of  the  service  rendered  by  the  book-keeper  in  recording 
the  transactions. 

Many  book-keepers,  in  fact  the  majority,  lack  scientific  training 
or  practical  experience,  assume  too  great  responsibilities  in  attempt- 
ing to  record  the  transactions  of  a  business.  The  result  generally 
is  a  badly  tangled  set  of  books  that  require  the  services  of  an 
auditor  for  their  verification  and  proper  adjustment. 

Incompetency,  however,  is  not  responsible  for  the  necessity  of 
securing  the  services  of  an  auditor  in  all  cases.  There  are  many  in- 
stances where  the  book-keeper,  although  fully  competent  to  do  the 
work,  is  expected  to  do  a  greater  amount  of  work  than  a  single  indi- 

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vidual  is  capable  of,  thereby  forcing  him  to  neglect  a  part  of  the 
work  until  he  eventually  loses  his  grip  upon  accuracy  and  errors 
creep  in. 

A  division  of  the  most  important  reason  is  made,  one  of  which 
is  inadequate  system,  the  other  inefficient  service.  Although  the 
book-keeper  is  expected  to  do  the  best  he  is  capable  of,  he  should 
not  be  relied  upon  entirely  for  assurance  that  a  proper  system  of 
accounting  is  employed.  He  may  do  his  work  in  an  entirely  satis- 
factory manner,  but  unless  provided  with  proper  tools  cannot  get 
satisfactory  results.  On  the  other  hand,  the  most  perfect  system 
ever  devised  will  not  produce  satisfactory  results  at  the  hands  of  an 
incompetent  book-keeper  lacking  necessary  judgment  and  discretion 
in  recording  the  business  transactions.  To  get  the  best  results  a 
good  system  of  accounting  and  efficient  service  are  essential. 

In  corroborating  the  above  remarks  extracts  from  the  report  of 
several  public  accounting  firms  upon  the  municipal  accounting  rec- 
ords of  a  western  city  are  submitted. 

"Nowhere  in  the  departmental  accounts  is  any  distinction  made 
between  capital  expenditures  (for  the  acquirement  of  permanent 
properties  and  equipment)  and  revenue  expenditures.  The  depart- 
mental records,  in  fact,  are  in  most  instances  merely  chronological 
lists  of  approved  disbursements,  and  as  such  are  without  value  for 
administrative  purposes.  The  Auditor  is  the  head  of  the  finance 
department  of  the  city  in  name  only.  There  is  no  system  of  audit. 
The  finance  committee  of  the  Board  of  Supervisors  employs  an  ac- 
countant to  examine  the  various  departments,  but  the  magnitude  of 
the  work  under  existing  accounting  conditions  is  far  beyond  the 
physical  ability  of  any  one  man  to  execute  efficiently.  It  follows 
that  the  department  books,  with  some  notable  exceptions,  are  not  in 
agreement  with  those  of  the  Auditor — a  condition  which  opens  the 
door  to  charges  to  wrong  accounts  and  to  the  making  of  fraudulent 
entries  without  fear  of  detection. 

Even  the  cash  accounting  is  not  complete.  There  is  no  ade- 
quate check  upon  all  collections,  and  thus  it  has  been  possible  for 
an  embezzlement  of  over  $90,000,  which  occurred  in  1906,  to  remain 
undetected  for  over  a  year  and  a  half.  A  comparison  of  the  depart- 
ment reports  of  the  Auditor  and  Treasurer  will  show  marked  differ- 
ences both  in  receipts  and  expenditures — possibly  "mere  matters  of 
book-keeping,"  but  even  so,  misstatements  of  fact  and  indications 
of  possible  hiding-places  for  error  and  fraud. 

8 


The  method  of  paying  city  employees  is  archaic,  wasteful,  time- 
consuming,  and  is  not  surrounded  with  sufficient  safeguards  to  in- 
sure a  day's  work  for  a  day's  pay.  It  speaks  volumes  either  for 
the  honesty  of  subordinate  employees  or  against  the  efficiency  of 
the  methods  that  there  have  been  no  scandals  in  connection  with  the 
pay-rolls. 

The  remedy  for  such  a  state  of  affairs  as  we  have  referred  to 
lies,  as  it  appears  to  us,  in  the  installation  of  a  modern  and  appro- 
priate system  of  accounts,  and  this  should  produce  results  far  more 
important  than  the  mere  recording  of  revenue  and  expenditures  or 
of  moneys  received,  moneys  disbursed  and  moneys  on  hand.  Such 
a  system  should  prove  an  essential  factor  in  the  safeguarding  of  the* 
assets  of  the  municipality,  and  in  the  economical  administration  of 
its  affairs.  It  should  accomplish  for  the  city  all  that  is  effected  by 
the  book-keeping  of  a  public  service  corporation  or  of  a  similar 
enterprise,  and  we  are  confident  that  it  is  only  by  adopting  such 
modern  accounting  methods  that  a  satisfactory  system  of  municipal 
accounts  can  be  developed." 

The  above  explanations  should  suffice  for  a  general  idea  of  the 
conditions  making  the  services  of  the  auditor  essential. 

THE  VALUE  OF  AN  AUDIT. 

The  value  of  an  audit  should  not  be  measured  by  the  actual 
discrepancies  or  irregularities  discovered,  since  there  are  other  con- 
siderations in  determining  the  benefits  derived  from  the  expenditure 
of  money. 

There  are  instances  where  a  comprehensive  audit  of  the  books 
of  a  business  does  not  disclose  any  discrepancies,  the  auditors  find- 
ing the  records  of  the  business  transactions  properly  made.  In 
such  cases  the  business  man  is  usually  too  hasty  in  his  judgment  in 
declaring  that  the  audit  proved  of  no  special  value  to  him  and  that 
the  amount  he  paid  therefor  represents  so  much  money  wasted. 

As  a  matter  of  fact,  there  is  a  deep  sense  of  security  and  satis- 
faction in  knowing  that  everything  in  connection  with  the  account- 
ing department  is  O.  K.,  that  no  irregularities  exist,  that  no  defalca- 
tions have  been  made,  that  everyone  identified  with  the  accounting 
department  in  any  manner  is  completely  exonerated  from  all  sus- 
picion, even  though  prior  to  the  time  the  audit  was  made  they  may 
have  been  suspected. 


Is  there  no  satisfaction  to  a  business  man  in  knowing  that  the 
accounting  department  has  not  made  expensive  errors,  that  goods 
have  not  been  shipped  out  without  being  properly  invoiced,  that 
purchases  have  been  returned  without  having  received  proper  credit 
therefor,  that  discounts  have  not  been  overlooked,  that  the  balance 
sheet  as  prepared  presents  a  thoroughly  reliable  statement  of  the 
conditions  of  the  business,  that  the  profit  and  loss  statement  shows 
a  correct  statement  of  the  profits  and  losses? 

The  business  man  employs  a  cashier  to  properly  record  in  the 
cash  book  all  cash  receipts  and  disbursements,  but  he  is  not  satisfied 
unless  he  has  some  check  upon  the  accuracy  of  the  record.  To 
verify  the  transactions  recorded  he  counts  the  cash  in  the  drawer  or 
till.  He  employs  a  night  watchman  who  is  relied  upon  to  prevent 
burglary,  fire,  etc.,  and  notwithstanding  the  fact  that  no  burglary  or 
fire  may  ever  occur  he  regards  the  services  of  the  night  watchman 
indispensable,  perhaps  on  account  of  the  sense  of  security  and  sat- 
isfaction to  him  in  knowing  that  his  property  is  protected.  Does 
it  not  naturally  follow  that  he  should  have  the  same  sense  of  secur- 
ity and  satisfaction  in  knowing  that  by  having  an  audit  of  his  books 
made  his  resources  are  protected? 

An  audit  is  designed  to  serve  a  double  purpose,  namely,  the 
detection  of  irregularities  or  defalcations,  etc.,  and  their  prevention. 
It  is  more  logical  for  a  business  man  to  employ  an  auditor  to  pre- 
vent irregularities  and  discrepancies  than  for  him  to  wait  until  they 
are  suspected  or  known  to  exist  before  steps  are  taken  to  locate 
the  errors  of  commission  or  omission  and  place  a  safeguard  against 
their  possible  recurrence. 

DIFFERENT  KINDS  OF  AUDITS. 

Audits  are  classified  under  the  headings  Completed,  Continuous, 
Partial,  Periodical  and  Special. 

An  audit  is  an  examination  and  investigation  of  books  of  ac- 
count for  the  purpose  of  determining  the  accuracy  of  the  accounts 
and  the  honesty  of  those  interested. 

They  are  usually  conducted  for  the  purpose  of  detecting  any 
fraud,  any  errors  of  a  technical  nature,  or  any  misapplication  of  the 
general  principles  of  accounting  which  does  not  affect  the  accuracy 
of  the  figures  shown. 

The  three  objects  above  classified  have  a  common  relation,  as 

10 


it  is  obvious  that  a  technical  error  or  an  error  of  principle  must  be 
necessary  to  conceal  a  fraud.  The  auditor  should  be  constantly 
vigilant  and  watchful  in  the  minutest  detail,  as  frauds  are  sometimes 
perpetrated  for  very  small  amounts,  although  in  many  instances 
large  amounts  have  been  involved. 

COMPLETED  AUDIT. 

A  completed  audit  is  so-called  because  the  auditor  does  not 
begin  his  work  until  after  the  trial  balance  has  been  taken. 

Whenever  possible  the  books  of  account  should  remain  in  the 
sole  custody  of  the  auditor  during  the  period  required  for  a  com- 
pleted audit,  although  this  is  hardly  practical  except  in  the  case  of 
very  small  concerns  where  the  work  is  so  arranged  that  it  requires 
very  little  detail  checking  by  the  auditor. 

The  difficulty  of  allowing  the  books  to  remain  in  the  possession 
of  the  book-keeper  during  the  period  of  the  audit  cannot  be  entirely 
overcome  with  practicability,  but  if  the  auditor  will  bear  in  mind 
this  special  feature  and  guard  against  any  fraudulent  intentions  of 
the  book-keeper,  he  can  undoubtedly  save  himself  from  any  danger 
from  this  source.  This  can  easily  be  remedied  if  the  auditor  will 
close  the  books  of  account  himself,  which  is  very  often  done.  Any 
changes  which  might  then  occur  would  certainly  be  detected. 

A  very  important  part  of  a  completed  audit  is  the  necessity  of 
the  auditor  in  completing  his  audit  on  any  part  of  the  work  which 
he  may  undertake,  that  is,  if  he  audits  the  total  ledger  balances  at 
any  particular  time  it  is  very  essential  that  he  take  the  sum  total 
of  such  balances  at  the  same  time  to  prevent  the  possibility  of 
changes  being  made  prior  to  the  time  of  making  the  addition  of  the 
balances. 


CONTINUOUS  AUDIT. 


A  continuous  audit  has  several  advantages  in  its  favor,  among 
which  are  the  following: 

Periodical  visits  of  the  auditor  have  a  tendency  to  remind  the 
book-keeper  that  he  must  keep  his  work  up-to-date  so  that  the 
auditor  is  not  hindered  on  this  account;  frequent  examinations  of 
the  books  readily  detect  any  errors  made,  so  that  they  may  be  cor- 
rected without  the  necessity  of  opening  special  adjustment  accounts; 

11 


frequent  examination  of  the  books  enables  the  auditor  to  give  more 
careful  attention  to  the  details  of  the  entries  and  the  general  prin- 
ciples of  accounting,  and  the  audit  may  be  completed  very  soon 
after  the  books  are  closed  without  the  necessity  of  the  auditor  rush- 
ing through  the  examination  slighting  smaller  details,  perhaps  to 
the  detriment  of  the  real  value  of  the  audit. 

Where  a  continuous  audit  is  made,  the  book-keeper  is  given 
an  opportunity  to  change  any  postings  or  figures  he  may  wish, 
ignorantly  or  intentionally,  prior  to  the  date  of  the  final  audit.  The 
auditor  in  charge  of  the  work  should  be  very  careful  to  detect  any 
changes  which  may  occur  and  to  make  special  note  thereof. 

PARTIAL  AUDIT. 

A  term  applied  to  a  system  of  auditing  which  does  not  cover 
the  principles  of  a  detailed  audit  nor  touch  upon  a  continuous  or 
completed  audit. 

In  conducting  a  partial  audit  it  is  customary  to  verify  the  cash 
and  bank  balances  upon  the  date  the  examination  is  started,  by 
comparing  the  same  with  the  balances  shown  by  the  ledgers. 

Special  ruled  paper  is  generally  used  for  the  purpose  of  opening 
accounts  with  the  various  general  or  private  ledger  accounts,  while 
controlling  accounts  are  opened  for  the  sales  and  purchase  ledgers. 
Postings  are  then  made  from  the  cash  book  and  journal  to  the  var- 
ious general  or  private  ledger  accounts,  and  from  the  purchase  and 
sales  records  postings  are  made  to  the  controlling  accounts. 

This  is  a  very  simple  matter  where  sectionalized  sales  ledgers 
are  used,  and  special  columns  provided  therefor  in  the  sales  records, 
but  when  this  is  not  done  considerable  confusion  will  arise  from 
having  many  items  of  a  different  nature  in  a  single  column. 

The  balances  then  shown  by  the  auditor's  abstract  ledger  should 
agree  with  the  balances  shown  by  the  book-keeper's  trial  balance, 
provided  the  book-keeper's  work  is  accurate.  If  any  differences  are 
discovered  special  mention  should  be  made  of  each,  and  all  the 
errors  located.  It  may  be  necessary  to  open  a  general  adjustment 
account  for  the  purpose  of  correcting  errors  which  usually  occur. 

The  balance  shown  by  the  sales  ledger  controlling-  account 
should  agree  with  the  total  sales  as  shown  by  the  sales  record,  and 
all  receipts  on  customers'  accounts,  discounts  and  allowances  as 
shown  by  the  cash  book,  journal  and  credit  records. 

12 


The  balance  shown  by  the  purchase  ledger  controlling  account 
should  agree  with  the  total  purchases  as  shown  by  the  purchase 
record,  and  all  payments  thereon,  together  with  discounts  and~allow- 
ances,  as  shown  by  the  cash  book,  journal  and  credit  allowance  rec- 
ord. Of  course,  the  balances  must  then  agree  with  the  ledger  bal- 
ances as  shown  by  the  trial  balance. 

A  simple  method  of  making  this  comparison  is  to  take  from 
the  trial  balance  at  the  commencement  of  the  audit  the  debit  and 
credit  balances  showing  sales  and  purchase  accounts  for  totals.  The 
debit  and  credit  postings,  as  shown  by  the  auditor's  abstract  ledger 
tor  the  audit  period,  should  then  be  listed  which  when  added  to  and 
deducted  from  the  previous  trial  balance  should  present  the  trial  bal- 
ance at  the  close  of  the  audit  period,  which  should  in  every  way 
agree  with  the  figures  as  presented  by  the  book-keeper.  Of  course, 
the  cash  on  hand  at  the  commencement  of  the  period  should  be 
added  to  the  amount  of  cash  received  during  the  audit  period.  From 
this  amount  should  be  deducted  the  amount  disbursed,  balance  rep- 
resenting the  cash  on  hand  at  close  of  the  period. 

In  closing  the  audit,  all  revenue  accounts  should  be  closed  into 
profit  and  loss,  and  a  statement  of  assets  and  liabilities  prepared. 
In  addition  to  this  the  general  verification  of  the  various  accounts, 
pay  roll,  petty  cash  footings,  bills  payable,  etc.,  should  be  made,  in 
order  that  the  audit  may  be  correct. 

PERIODICAL  AUDIT. 

A  term  given  to  an  audit  conducted  at  certain  specified  times, 
or  a  series  of  audits  covering  certain  prescribed  periods.  Periodical 
audits  usually  assume  the  nature  of  a  completed  audit. 

SPECIAL  AUDITS. 

A  term  sometimes  applied  to  the  special  considerations  in  dif- 
ferent classes  of  audits,  such  as:  public  service  corporation,  commer- 
cial accounts,  and  the  accounts  of  various  institutions. 

AUDITORS'  CERTIFICATES. 

Auditors  have  not  adopted  any  particular  form  of  certificate  as 
conditions  to  be  met  vary  slightly  in  different  businesses  and  yet 
the  general  principles  of  certifications  are  practically  the  same. 

13 


Two  or  three  forms  of  auditors'  certificates  are  given  which 
meet  ordinary  requirements. 

;'I  hereby  certify  that  I  have  carefully  examined  the  books  of  account 
of  Fred  Andrews  &  Company,  and  that  the  above  statement  of  assets  and 
liabilities  and  balance  sheet  is  a  true  and  correct  statement  of  the  present 
condition  of  the  business  as  on  the  30th  day  of  June,  1908,  according  to  the 
said  books  of  account,  dated  this  9th  day  of  July,  1908." 

(  Signed) 

"We  hereby  certify  that  we  have  carefully  audited  the  accounts  of  the 
Wolverine  Manufacturing  Company  for  the  fiscal  year  ending  June  30th,  1907, 
and  that  the  same  are  apparently  correct.  We  further  certify  that  the  state- 
ment of  assets  and  liabilities  and  balance  sheet  above  shown  is  accurately 
prepared  from  the  accounts  as  shown  by  the  books  of  the  company,  and  to 
the  best  of  our  knowledge  and  belief,  and  is  a  correct  statement  of  the 
financial  condition  of  the  company,  as  of  the  date  above  mentioned." 

"I  hereby  certify  that  I  have  audited  the  above  balance  sheet  of  the 
Land  Improvement  Company,  dated  the  31st  day  of  December,  1907,  and  in 
my  opinion  such  balance  sheet  exhibits  a  true  and  correct  statement  of  the 
affairs  of  the  said  company,  as  shown  by  their  books  of  account,  as  of  the 
date  mentioned." 

AUDITORS'  DUTIES. 

The  duties  of  the  auditor  are  governed  very  largely  by  the 
agreements  set  forth  in  his  contract  for  the  audit  or  investigation 
undertaken. 

The  duties  of  an  auditor  in  behalf  of  a  company  about  to  be 
amalgamated  or  sold  to  a  combination  differ  greatly  from  the  duties 
of  the  auditor  employed  by  a  large  corporation  for  the  purpose  of 
conducting  a  continuous  audit,  and  further  difference  in  the  nature 
of  the  examinations  and  investigations  cause  wide  differences  in  the 
auditors'  duties  under  varied  conditions. 

The  auditor  for  a  large  corporation,  when  employed  for  the  pur- 
pose of  making  a  continuous  audit,  is  expected  to  verify  all  of  the 
accounting  work  of  the  corporation  and  prepare  periodical  compar- 
ative statistical  statements  of  the  financial  condition  of  the  business, 
after  having  verified  the  figures  presented.  He  is  further  expected 
to  endorse  the  system  of  accounts  in  use  and  to  make  such  changes 
from  time  to  time  as  in  his  best  judgment  is  deemed  advisable,  and 
suggest  any  labor-saving  improvements  or  short  cuts. 

There  is  considerable  difference  between  the  auditor  of  a  cor- 
poration and  the  public  accountant  or  auditor,  inasmuch  as  the  for- 

14 


mer  does  not  have  the  privilege  of  a  free  hand  in  his  recommenda- 
tions on  account  of  certain  restrictions  and  limitations  being  placed 
upon  the  extent  of  his  suggestions,  recommendations,  etc.,  the  pub- 
lic accountant  or  auditor  is  not  bound  by  any  personal  responsibility 
and  conducts  an  audit  from  an  impartial  and  unbiased  standpoint. 

The  permanent  auditor  employed  by  the  corporation  usually 
considers  whether  or  not  his  recommendations  will  meet  with  the 
approval  of  the  higher  authorities,  and  whether  or  not  such  recom- 
mendations will  cause  personal  embarrassment  as  regards  the  per- 
manency of  his  position.  This  restriction  or  limitation  places  the 
permanent  auditor  in  a  rather  undesirable  position,  and  gives  him 
very  little  advantage  over  the  expert  book-keeper. 

The  permanent  auditor  is  governed  in  his  work  by  the  basis  of 
the  contract  with  the  principals  for  the  work  undertaken,  and  inas- 
much as  none  of  the  courts  or  legislatures  have  attempted  to  define 
an  auditor's  duties,  the  responsibilities  of  an  audit  rest  with  the 
individual.  It  would  be  impractical  for  any  court  or  legislature  to 
regulate  the  duties  of  the  auditor,  as  such  regulations  might  result 
in  failure  in  many  cases. 

AUDITORS'  LIABILITIES. 

There  are  wide  differences  of  opinion  as  regards  the  liabilities 
of  the  auditor  and  no  definite  conclusion  can  be  gained  as  to  the 
auditor's  liability  in  connection  with  accounts  certified  by  him. 

An  auditor  is  expected  to  be  honest  and  to  exercise  a  reason- 
able amount  of  care  and  skill  to  determine  that  his  certification  is 
true  and  correct,  and  to  exercise  a  reasonable  amount  of  care  and 
skill  in  determining  the  truth.  It  would  be  unfair  for  the  auditor 
to  assume  the  liabilities  of  the  directors  of  a  corporation,  although 
it  is  his  duty  to  examine  any  and  all  features  in  connection  with 
the  books  of  account,  valuations,  etc.,  and  to  specify  any  differences 
found. 

Should  any  valuations  cause  suspicion  investigation  should  fol- 
low, but  if  such  valuations  are  unreasonable  and  the  directors  are 
not  in  accord  with  the  auditor  as  to  the  amount  of  such  valuations, 
then  he  can  hardly  be  held  responsible,  but  his  certification  should 
embody  the  truth. 

The  auditor  is  expected  to  know  and  to  certify  to  the  truth  and 
accuracy  of  the  figures  shown  upon  the  balance  sheet  after  exercis- 

15 


ing  reasonable  care  to  satisfy  himself  that  the  figures  shown  are 
correct,  although  if  his  suspicion  is  aroused  investigation  should 
result  and  in  making  his  report  to  shareholders  the  details  should 
be  so  explained  and  illustrated  that  they  may  take  whatever  action 
in  the  matter  that  they  may  see  fit. 

The  liabilities  of  an  auditor  become  a  matter  of  serious  regard 
when  the  affairs  of  a  company  are  wound  up  on  account  of  dividends 
having  been  declared  and  paid  out  of  capital.  Of  course,  the  direc- 
tors in  such  cases  are  responsible,  and  it  would  seem  that  an  auditor 
should  be  held  equally  responsible  with  the  directors  provided  he 
should  discover  this  fact  and  fail  to  specify  its  importance  in  his 
certification,  although  an  auditor  should  not  be  personally  liable  for 
innocent  mistakes  or  ignorance.  Corporations  should  exercise  due 
care  to  cover  this  latter  point  in  engaging  the  services  of  an  auditor. 

It  may  be  considered  that  under  certain  other  conditions,  such 
as  the  following,  the  auditor  might  be  personally  liable. 

Suppose  the  auditor  has  a  contract  with  a  large  corporation  for 
the  periodical  audit  of  its  books  of  account,  and  instead  of  auditing 
the  books  promptly  upon  the  specified  date  allows  his  audit  to  fall 
jin  arrears  for  a  period  of  ten  days  or  two  weeks  when  he  then  dis- 
covers that  during  the  past  two  months  or  perhaps  a  longer  period 
continuous  defalcation  has  been  practiced,  the  question  then  arises 
as  to  the  liability  of  the  auditor  for  not  detecting  and  preventing 
such  defalcation  upon  the  specified  contract  audit  date  instead  of  ten 
days  or  two  weeks  thereafter. 

In  such  an  instance  the  auditor  should  be  held  liable  for  defal- 
cations occurring  by  reason  of  his  negligence,  although  the  definite 
conclusion  on  this  question  is  conditional,  inasmuch  as  it  might 
reasonably  be  expected  that  some  elasticity  should  be  endured  at 
certain  periods,  for  example,  January  1st,  when  the  auditor  is  gen- 
erally expected  to  undertake  a  far  greater  amount  of  work  than  is 
possible  for  him  to  do  within  a  limited  period. 

AUDITORS'  RESPONSIBILITIES. 

Although  a  great  deal  has  been  published  concerning  the  au- 
ditors' responsibilities  and  liabilities,  it  would  be  hardly  considered 
justifiable  for  an  auditor  personally  to  be  held  responsible  for  his 
failure  to  detect  or  expose  errors  or  frauds  in  his  examination  and 
investigation,  unless,  in  addition  to  negligence,  such  errors  or  frauds 

16 


were  overlooked  with  fraudulent  intent,  in  which  case  it  is  clearly 
evident  that  an  auditor  might  personally  be  held  responsible. 

AUDITORS'  QUALIFICATIONS. 

Although  a  great  deal  has  been  published  regarding  the  qualifi- 
cations of  a  successful  and  efficient  auditor  there  is  undoubtedly  lit- 
tle difference  of  opinion  regarding  the  qualification  of  the  auditor 
who  is  considered  first-class  in  every  sense  of  the  word,  as  applied  to 
the  accounting  and  auditing  profession. 

In  order  to  achieve  complete  success  in  the  accounting  and 
auditing  field  an  auditor  must  have  a  very  thorough  and  exhaustive 
knowledge  of  every  branch  and  department  of  bookkeeping,  which 
is  merely  the  bottom  rung  to  his  art.  He  must  also  acquaint  him- 
self with  the  statutes  regulating  the  different  undertakings  with 
which  he  may  associate  himself  or  in  which  he  may  be  concerned. 
In  addition  to  having  a  thorough  and  practical  knowledge  of  com- 
mercial business  and  commercial  transactions  generally,  he  must 
possess  a  considerable  knowledge  of  the  particular  methods  by 
which  various  lines  of  business  are  conducted. 

An  auditor  should  be  a  man  of  considerable  knowledge, ,  prac- 
tice, experience  and  skill,  and  should  be  equipped  with  a  knowledge 
of  as  many  trades  and  customs  as  possible.  A  detailed  knowledge 
of  banking  and  finance  and  stock  exchange  operations  is  an  essential 
to  his  complete  success.  He  should  be  a  man  of  exceptional  ability 
in  the  perception  of  details  and  plans,  a  man  with  originality  so 
that  he  may  formulate  ideal  systems,  and  above  all  things  a  man 
with  a  memory  trained  for  detail  work. 

The  auditor  will  be  very  much  surprised  to  find  how  valuable 
little  experiences  are  to  him  after  a  period  of  time,  and  by  having 
a  good  memory  for  the  little  incidents  which  occur  in  his  daily 
work  he  will  later  be  able  to  save  much  time  and  will  thus  be 
equipped  for  better  service. 

It  has  been  stated  that  among  the  qualifications  of  an  auditor 
should  be  considered  those  which  are  not  acquired  by  careful  study 
but  by  living.  Among  these  qualifications  which  make  up  the  good 
auditor  are  the  following:  Tact,  caution,  firmness,  fairness,  good 
temper,  courage,  discretion,  industry,  judgment,  patience,  clear  head- 
edness  and  reliability,  while  that  judicious  and  liberal  education 

17 


which  is  expressed  by  the  word  culture  is  most  important  for  those 
who  would  achieve  the  greatest  successes. 

Accountancy  demands  a  width  and  depth  of  general  knowledge 
upon  which  it  is  impossible  to  place  a  limit,  and  any  leading  ac- 
countant will  gladly  admit  that  something  new  is  learned  every  day. 

ESSENTIALS  OF  AN  AUDIT. 

There  are  many  considerations  under  this  heading  in  addition 
to  an  outline  of  what  an  audit  should  cover  or  contain. 

The  twentieth  century  will  ever  be  known  as  an  era  of  large 
corporations,  amalgamations,  trusts  and  combinations  of  capital, 
some  of  which  are  conducted  upon  good  business  principles  while 
others  attempt,  and  too  frequently  carry  out,  lawless  practices,  aim- 
ing for  success  in  the  monopolization  of  trade  or  in  deceiving  the 
public  into  buying  their  securities  at  fictitious  values.  Those  cor- 
porations conducted  upon  sound  business  principles  endeavor  to 
keep  their  floating  assets  equivalent  to  their  floating  liabilities,  with 
a  margin  of  profit  which  represents  the  excess  of  the  former  over 
the  latter. 

That  a  corporation  is  regarded  as  honest  which  attempts  no 
lawless  practices,  issues  or  sells  no  watered  stock,  calculates  its 
earning  power  from  a  proper  and  conservative  basis  and  declares 
dividends  out  of  profits  payable  in  cash.  The  stock  of  such  a  cor- 
poration is  usually  worth  the  value  at  which  it  is  shown  upon  the 
books  of  account. 

The  advance  in  accounting  methods  and  principles  has  brought 
enlightenment  to  the  investor  who  does  not  now  regard  favorably 
an  investment  in  any  enterprise  unless  the  annual  report  is  pre- 
pared in  a  clear  and  comprehensive  manner  thereby  making  it  un- 
necessary for  him  to  employ  counsel  or  the  advice  of  a  credit  man, 
accountant  or  an  attorney  to  determine  of  what  the  assets  consist 
and  what  constitutes  the  liabilities.  A  complete  and  comprehensive 
report  accompanying  a  dividend  check  greatly  increases  the  confi- 
dence of  the  investor  in  the  proposition  and  is  naturally  productive 
of  the  very  best  results,  while,  on  the  other  hand,  an  annual  report 
inaccurately  or  improperly  prepared  and  submitted  to  a  stockholder 
arouses  suspicion  and  causes  dissatisfaction. 

A  corporation  requires  no  special  analysis.  It  is  sufficient  to 
say  that  it  is  a  combination  of  capital.  It  is  the  result  of  a  few  or 

18 


many  investors  putting  their  funds  into  an  enterprise  and  obtaining 
corporate  power  from  the  state  under  the  laws  of  which  the  cor- 
poration is  organized.  In  many  instances  a  large  corporation  in  a 
community  depends  upon  the  best  citizens  of  that  locality  for  the 
sale  of  its  securities. 

It  is  universal  knowledge  that  the  primary  object  of  the  in- 
vestor is  a  dividend  from  the  money  invested.  While  it  is  natural 
for  an  investor  to  regard  the  dividend  earning  power  of  a  corpora- 
tion as  its  primary  purpose  he  should  not  overlook  the  fact  that  a 
large  business  enterprise  is  unquestionably  an  enormous  power  for 
good  in  a  community.  The  altruistic  benefit  derived  from  the  em- 
ployment of  thousands  of  laborers  may  be  regarded  of  more  im- 
portance than  the  small  dividend  the  investor  expects.  A  corpora- 
tion having  an  annual  pay  roll  of  $100,000  might  return  to  its  stock- 
holders dividends  not  exceeding  $10,000.  The  circulation  of  the 
labor  expenditure  in  the  community  among  the  families,  grocers, 
merchants,  druggists,  etc.,  might  be  considered  the  existence  of  the 
community. 

The  investor  who  receives  a  regular  annual  dividend  upon  his 
investment  accompanied  by  an  annual  statement  for  a  period  of  a 
few  years  may  take  it  for  granted  that  everything  is  all  right  and 
become  negligent  in  his  regard  for  protection  or  the  safety  of  his 
investment.  In  the  smaller  communities  the  positions  of  trust  and 
responsibility  with  corporations  should  fall  to  reputable  citizens  who 
are  reliable  and  may  be  depended  upon  in  any  crisis  to  safeguard 
the  interests  of  the  laborer  and  the  investor  alike.  Very  seldom  do 
we  hear  of  defalcations  in  such  cases.  The  larger  concerns  find  it 
necessary  to  employ  auditors  to  check  up  cash  receipts  and  dis- 
bursements, in  fact,  at  least  an  annual  audit  by  a  disinterested  party 
is  now  becoming  the  prevailing  custom. 

As  already  stated,  an  audit  is  essential;  next  for  consideration 
is  the  essentials  of  an  audit,  an  audit  that  will  protect  the  interests 
involved. 

In  the  first  place  it  should  be  conducted  as  expeditiously  as 
possible  to  avoid  unduly  disturbing  the  regular  routine  of  the  work. 
Sales  are  regarded  as  the  foundation  and  the  force  which  moves  th^ 
wheels  of  any  enterprise,  therefore  they  constitute  the  most  im- 
portant factor  as  an  accruing  asset  of  the  business  to  be  dealt  with 
by  the  auditor.  The  amount  of  this  accruing  asset,  or  sales,  should 

19 


first  be  definitely  established.  This  is  a  comparatively  easy  under- 
taking, where  proper  sales  records  are  kept,  especially  where  an 
adding  machine  is  used.  Having  established  the  definite  amount  of 
sales  next  for  consideration  is  the  amount  of  cash  receipts  received 
from  this  asset  and  the  open  accounts  remaining  uncollected. 

Marketable  goods  place  a  responsibility  upon  the  sales  man- 
ager, while  goods  parted  with,  sold  to  a  customer  or  invoiced  and 
the  account  placed  upon  the  ledger,  place  a  responsibility  upon  the 
treasurer  or  collector.  The  treasurer  is  expected  to  bring  into  the 
business  in  cash  the  equivalent  for  the  goods  sold.  If  the  sales 
manager  disposed  of  $7,500  worth  of  goods  in  a  day  and  the  treas- 
urer received  from  the  different  customers  remittances  amounting 
to  $5,000  and  there  were  $2,500  worth  of  accounts  uncollected  the 
business  might  properly  regard  its  interests  protected.  The  treas- 
urer can  vouch  for  his  cash  receipts  by  depositing  the  funds  in  the 
bank  and  taking  the  pass  book  entries  as  receipt  therefor. 

The  company  itself,  as  far  as  the  protection  of  its  interests  is 
concerned,  cares  to  pay  little  or  no  attention  to  the  manner  or 
methods  of  making  the  collections,  its  interest  lying  in  the  actual 
cash  returns.  The  customers  may  be  relied  upon  to  see  that  the 
goods  are  properly  invoiced  and  that  they  receive  proper  credit  for 
remittances,  since  they  would  neither  allow  themselves  to  be  over- 
charged nor  would  they  pay  an  account  a  second  time. 

In  striking  a  balance  between  the  accruing  assets,  or  sales,  and 
the  actual  cash  receipts  and  open  accounts  uncollected  a  satisfac- 
tory accounting  of  the  first  consideration  or  essential  of  an  audit 
is  made.  When  this  equilibrium  is  established  it  is  considered 
unnecessary  for  the  auditor  to  examine  each  individual  invoice, 
although  in  all  cases  the  billing  department  of  an  enterprise  is 
usually  the  heaviest  item  in  an  audit. 

Having  received  the  cash  and  deposited  it  in  the  bank  many 
safeguards  are  placed  around  the  disbursements,  while  the  treasurer 
regards  the  endorsement  upon  the  back  of  the  check  as  sufficient 
receipt  for  the  disbursement  and  evidence  of  payment.  In  other 
words,  the  closed  transactions  are  the  ones  which  bring  the  respon- 
sibilities to  the  treasurer.  His  responsibility  may  be  considered 
two-fold.  When  the  sales  manager  has  created  the  account  by 
making  the  sale  he  is  expected  to  get  the  return  equivalent  in  cash, 
and  when  he  has  received  the  cash  he  is  held  responsible  for  a 
proper  accounting  thereof. 

20 


A  special  column  should  appear  upon  the  left-hand  or  debit 
side  of  the  cash  book  in  which  to  enter  the  amount  of  all  cash 
receipts  from  sales.  The  sales  record  shows  the  amount  of  the 
accruing  assets.  It  is  unnecessary  to  take  the  cash  balance  into 
consideration  in  order  to  prove  the  reliability  or  unreliability  of 
the  treasurer  in  his  first  responsibility.  The  total  sales  shown  by 
the  sales  record  minus  cash  receipts  shown  by  the  special  column 
upon  the  debit  side  of  the  cash  book  must  agree  with  the  outstand- 
ing accounts  uncollected  upon  the  ledger.  If  the  sales  for  the 
month  are  $50,000,  the  treasurer  shows  bank  deposits  upon  his 
pass  book  of  the  cash  receipts  from  the  sales  amounting  to  $40,000 
and  $10,000  in  outstanding  accounts  uncollected  it  is  sufficient  that 
the  company's  interests  are  protected.  This  principle  applies  to 
the  transactions  for  one  day,  one  week,  one  month,  six  months  or 
one  year.  This  principle  is  outlined  in  its  simplest  form  that  it 
may  be  properly  understood.  However,  explanation  is  necessary  to 
provide  for  returned  merchandise,  unpaid  drafts  or  errors  in  invoices. 

In  speaking  of  sales,  net  sales  are  understood,  that  is,  gross 
sales  less  returned  merchandise  or  deductions  for  errors  in  invoicing, 
etc.  Cash  receipts  have  reference  to  net  cash  receipts  irrespective 
of  unpaid  drafts,  etc.  An  audit  gives  protection  to  the  bookkeeper 
or  treasurer,  and  to  the  directors  and  stockholders. 

In  supporting  the  ideas  suggested  attention  is  directed  to  the 
system  of  accounting  employed  by  practically  all  of  the  railroads 
of  the  United  States.  The  ticket  agent  at  each  station  is  supplied 
with  a  certain  number  of  tickets,  for  various  destinations.  At  the 
end  of  each  month  or  other  specified  period  the  agent  is  called  upon 
to  produce  the  equivalent  in  cash  for  all  tickets  sold  which,  added  to 
the  value  of  the  tickets  on  hand  unsold,  must  agree  with  the  value 
of  the  tickets  originally  given  to  him.  The  freight  agent  issues  way 
bills  for  all  shipments  outgoing  and  pros  for  all  shipments  incoming. 
The  traveling  auditor  visits  the  freight  agent  at  varying  intervals 
unannounced  and  investigates  merely  to  determine  if  the  freight 
agent  has  accounted  for  in  cash  the  difference  between  the  sum 
total  of  the  way  bills  and  pros  issued  and  the  outstanding  accounts 
for  freight  charges. 

These  remarks  are  for  consideration  separate  and  apart  from 
the  instructions  for  auditing  outlined  in  succeeding  pages. 

21 


A  PRACTICAL  SYSTEM  OF  AUDITING. 

The  system  of  auditing  described  is  designed  to  cover  the  fullest 
requirements  of  a  completed  audit  showing  the  progress  of  the  audit 
step  by  step,  as  well  as  an  outline  of  the  many  smaller  considera- 
tions incidental  to  an  examination  and  investigation  of  the  account- 
ing records  of  a  business. 

THE   AUDITOR'S   CONTRACT. 

When  employing  an  auditor  for  the  examination  and  investiga- 
tion of  the  accounting  records  of  a  business  the  management  should 
enter  into  an  agreement  with  the  auditor  under  which  he  is  to  carry 
out  certain  performances.  Unless  the  contract  specifically  states  the 
extent  to  which  the  auditor  shall  go  in  making  his  investigations  an 
unlimited  opportunity  for  disagreement  and  dissatisfaction  arises 
because  the  employer  may  claim  that  the  auditor  was  expected  to 
make  a  comprehensive  investigation  even  to  the  minutest  detail, 
while  the  auditor  may  claim  that  he  was  expected  to  make  a  general 
audit  without  going  to  the  extreme  in  all  cases. 

The  contract  should  also  state  in  what  manner  the  auditor  is  to 
be  paid  for  his  services,  that  is,  if  he  shall  be  paid  so  much  per 
hour  or  day  for  the  full  amount  of  time  required  to  complete  the 
audit,  or  if  he  shall  receive  a  stipulated  sum  for  the  work  specified 
in  the  contract  irrespective  of  the  amount  of  time  required  by  him 
to  complete  it.  It  is  an  easy  matter  for  the  average  employer  to 
overlook  the  importance  of  this  detail  because  so  few  understand 
the  exact  nature  and  extent  of  the  auditor's  investigations. 

The  contract  should  also  clearly  set  forth  the  period  to  be  cov- 
ered by  the  auditor  in  his  investigation,  that  is,  if  he  shall  verify 
the  records  of  transactions  as  recorded  for  a  period  of  six  months 
prior  to  the  date  upon  which  the  work  is  commenced  or  for  the 
previous  or  current  fiscal  year  of  the  company's  existence,  etc.  He 
may  be  employed  for  the  purpose  of  making  a  pay  roll  audit  only; 
on  the  other  hand  his  investigation  may  be  confined  solely  to  a 
verification  of  the  capital  stock  of  a  corporation  and  the  number  of 
shares  sold,  issued,  unsubscribed,  unissued,  shares  in  the  treasury, 
etc.  He  may  be  employed  to  investigate  the  nature  of  a  reserve 
shown  upon  the  balance  sheet,  that  is,  he  may  be  expected  to  deter- 

22 


mine  to  his  entire  satisfaction  if  the  reserve  is  an  actual  available 
fund  or  if  it  is  merely  a  book  reserve. 

However,  experience  has  proven  that  practically  all  business 
houses  demand  a  completed  audit  covering  every  department  of  their 
business  involving  an  examination  and  investigation  of  the  records 
affecting  all  departments,  as  well  as  the  various  forms  of  records 
kept  in  those  departments. 

A  MEANS  OF  CO-OPERATION. 

Upon  completion  of  a  contract  between  the  employer  and  the 
auditor  setting  forth  the  details  of  the  performances  required  to  be 
carried  out  by  the  auditor  and  the  agreements  made  by  the  employer, 
both  of  which  are  in  mutual  accord  and  entirely  satisfactory  to  both 
parties  to  the  agreement,  the  auditor  is  then  in  a  position  to  take 
up  his  work,  conducting  the  investigation  personally  or  through  his 
staff  of  trained  assistants. 

One  of  the  very  first  things  which  the  auditor  should  do  is  to. 
cultivate  the  acquaintance  of  the  individual  who  has  been  in  abso- 
lute charge  of  the  accounting  department  of  the  business  and  who 
has  been  held  responsible  for  a  proper  record  of  the  transactions  of 
the  business  during  the  period  which  the  audit  is  to  cover.  The 
principal  purpose  of  the  auditor  in  forming  such  an  acquaintance  is 
one  of  profit,  since  there  is  no  one  else  who  reasonably  may  be 
expected  to  know  as  much  about  the  transactions  of  the  period  in 
question  as  the  individual  in  charge  of  the  records.  As  a  matter  of 
fact,  the  auditor  should  cultivate  his  acquaintance  with  the  idea  of 
getting  any  co-operation  which  he  may  need  to  satisfy  himself 
beyond  reasonable  doubt  that  when  his  work  is  finished  his  investi- 
gation has  been  thorough  and  comprehensive,  and  the  results  ob- 
tained correct  and  according  to  the  actual  transactions  of  the 
business  as  made. 

It  is  in  this  particular  that  the  auditor  is  expected  to  exercise 
his  very  best  judgment  and  discretion  in  order  that  no  misunder- 
standing shall  arise  between  them  which  might  hinder  his  making 
rapid  progress  in  the  audit  or  decrease  the  value  of  the  results 
obtained  even  in  the  slightest  degree.  To  a  certain  extent  the 
attitude  of  the  auditor  towards  this  individual  may  make  his  work 
comparatively  easy  or  extremely  difficult  and  unsatisfactory,  because 
un  the  one  hand  the  co-operation  of  the  individual  wrho  has  made 

23 


the  records  is  unquestionably  very  beneficial,  while  on  the  other 
hand  his  attitude  of  antagonism  might  cause  an  unlimited  amount 
of  trouble. 

The  most  valuable  information  sought  by  the  auditor  from  the 
individual  in  charge  of  the  accounting  department  is  a  comprehen- 
sive understanding  of  the  nature  of  the  business,  the  manner  in 
which  the  business  is  conducted,  the  nature  of  the  transactions,  the 
methods  of  doing  business,  the  methods  employed  by  the  accounting 
department  in  recording  the  transactions  and  the  methods  employed 
by  the  individuals  in  all  other  departments  or  branches  of  the  busi- 
ness, particularly  the  executive  end  of  the  work  instead  of  the 
manufacturing. 

If  a  completed  audit  is  made  the  auditor  desires  to  familiarize 
himself  with  the  methods  employed  for  handling  incoming  remit- 
tances and  making  deposits,  disbursements  by  check  and  petty  cash 
•disbursements,  confirmation  of  orders,  invoicing,  purchasing,  pay 
roll  records,  discounting  notes  or  bills,  accepting  or  drawing  drafts, 
taking  or  allowing  discounts,  methods  of  taking  inventories,  etc. 
The  auditor  should  also  use  his  best  efforts  to  determine  what 
records  are  kept  of  the  transactions,  that  is,  the  nature  of  all  books 
used  or  card  index  records  of  any  nature,  loose  leaf  methods,  etc., 
voucher  checks,  purchase  orders,  acknowledgments,  etc. 

BOOKS  AND  RECORDS  FOR  INVESTIGATION. 

In  the  majority  of  cases  the  books  and  records  for  investigation 
consist  of  the  cash  book,  check  register  or  voucher  register,  petty 
cash  blotter  or  receipt  book,  bills  receivable  record  or  legister,  bills 
payable  record  or  register,  inventory  records,  purchase  record,  pur- 
chase order,  sales  record  containing  copies  of  invoices  rendered  or 
sales  recapitulation  record,  confirmation  of  orders  received  or  ship- 
ping record,  journal  for  cross,  adjusting  and  closing  entries  (in 
some  instances  a  private  journal)  general  or  private  ledger,  (in 
some  instances  the  general  ledger  serves  also  the  purpose  of  the 
private  ledger)  purchase  ledger,  sectionalized  sales  ledgers,  records 
of  returned  goods  from  sales,  records  of  returned  goods  purchased, 
system  of  credit  memoranda  for  rebates,  allowances,  overcharges, 
railroad  claims,  etc.,  dividend  register,  corporation  record  containing 
minutes  of  regular  and  annual  meeting  of  stockholders  and  directors, 
"by-laws,  subscription  records,  stock  ledger  containing  accounts  with 
stockholders,  etc. 

24 


The  relative  importance  of  each  of  the  records  above  mentioned 
is  fully  explained  in  the  succeeding  pages,  containing  a  compre- 
hensive outline  of  a  practical  system  of  auditing  the  books  of  any 
individual,  partnership,  corporation,  society  or  joint  stock  associa- 
tion. Briefly  stated,  the  auditor  should  have  access  to  all  books  of 
original  entry,  that  is,  those  in  which  the  preliminary  record  of  a 
transaction  was  first  written,  those  accepted  as  authority  on  all 
questions  involved  in  a  transaction  or  a  series  of  transactions. 

VERIFICATION  OF  CASH  BALANCE. 

As  soon  as  the  auditor's  contract  is  satisfactorily  completed  and 
the  auditor  or  members  of  his  staff  have  put  forth  their  best  efforts 
to  secure  the  co-operation  of  the  individual  who  has  been  in  direct 
charge  of  the  accounting  records  of  the  business  about  to  be  audited, 
and  has  acquired  a  general  knowledge  of  the  manner  in  which  the 
business  is  conducted  and  the  transactions  recorded,  as  well  as  a 
complete  list  of  all  books  of  record  which  will  be  required  during 
the  investigation,  they  then  verify  the  cash  on  hand,  in  the  drawer. 

The  cash  on  hand  usually  consists  of  two  separate  funds.  The 
difference  between  the  footings  upon  the  debit  side  of  the  cash  book 
or  record,  showing  cash  receipts,  and  the  record  of  bank  deposits 
which  usually  appears  upon  the  check  register  shows  the  amount 
of  cash  on  hand  for  deposit.  This  amount  may  be  in  the  form  of 
checks,  drafts,  currency,  gold,  silver  or  fractional  coin.  The  auditor 
then  makes  a  detailed  list  of  the  cash  on  hand  in  the  following 
manner: 

He  makes  a  record  of  each  check,  giving  the  name  of  the 
drawer,  and  of  each  draft,  followed  by  the  number  of  each  denom- 
ination of  bills,  gold,  silver  or  fractional  coin,  that  is,  he  shows  the 
number  of  twenty,  ten,  five,  two  or  one  dollar  bank  notes,  the 
number  of  double  eagles,  eagles,  five  and  two  and  a  half  dollar  gold 
pieces,  the  number  of  dollars,  halves,  quarters,  dimes,  nickels  and 
pennies.  Extensions  are  made  and  the  footing  taken  which  shows 
the  total  cash  on  hand  for  deposit.  The  balance  of  cash  on  hand 
should  agree  with  the  difference  between  the  footings  upon  the 
debit  side  of  the  cash  book  showing  cash  receipts  and  the  footings 
of  the  bank  deposit  record  showing  total  amount  deposited.  If  any 
discrepancy  occurs,  whether  the  cash  on  hand  is  in  excess  of  the 
bialance  as  shown  by  the  record,  or  if  there  is  a  shortage,  the  auditor 

25 


makes  note  of  this  fact,  as  he  will  have  occasion  to  further  verify 
the  cash  transactions  as  recorded  as  he  proceeds  with  his  audit. 

He  then  turns  to  the  petty  cash  fund,  which  is  usually  found 
in  every  business.  He  first  determines  the  original  amount  of  the 
fund  and  then  deducts  the  amount  of  the  petty  cash  disbursements 
as  evidenced  either  by  a  petty  cash  blotter  or  petty  cash  receipts 
taken  for  the  several  disbursements.  The  difference  between  the 
amount  of  the  original  fund  and  the  disbursements  gives  the  amount 
of  petty  cash  which  should  be  on  hand.  The  auditor  then  makes  a 
list  of  the  petty  cash  showing  the  number  of  each  denomination  of 
bills,  gold,  silver  and  fractional  coin,  making  extensions  and  taking 
the  total  verifying  the  amount  of  actual  petty  cash  on  hand  as  shown 
by  his  list  with  the  amount  that  there  is  supposed  to  be  on  hand, 
According  to  the  petty  cash  record.  If  there  is  any  shortage  the 
auditor  makes  note  of  the  fact.  If,  for  any  reason,  there  is  more 
cash  on  hand  than  is  called  for  by  the  record  he  also  makes  note 
thereof,  as  the  bookkeeper  or  cashier  may  have  made  an  error  in 
his  favor  in  handling  the  money. 

VERIFICATION  OF  THE  BANK  BALANCE. 

In  verifying  the  bank  balance  the  auditor  secures  from  each 
bank  with  which  the  company  transacts  business  a  certificate  show- 
ing the  balance  on  deposit  to  the  credit  of  the  company  at  the  close 
of  the  period  the  audit  covers  according  to  his  contract.  Each  bank 
should  also  be  required  to  certify  to  a  record  of  all  notes  which 
they  have  discounted  for  the  company  which  they  are  holding  as 
collateral  security  on  loans  and  any  liability  of  the  company  known 
to  the  bank  by  reason  of  the  company's  having  endorsed  notes  for 
anyone  else  which  thus  become  a  contingent  liability  of  the  business. 

A  reconciliation  of  the  bank  balance  at  the  date  upon  which 
the  audit  closes  naturally  includes  a  record  of  all  deposits  made 
during  the  period,  a  record  of  all  checks  issued,  paid  and  returned  to 
the  company  and  the  final  statement  showing  the  numbers  and 
amounts  of  all  checks  issued,  outstanding  and  unpaid.  The  differ- 
ence between  the  bank  balance  as  shown  by  the  certificate  furnished 
by  the  bank  and  the  amount  of  outstanding  checks  unpaid  should 
agree  with  the  bank  balance  shown  by  the  check  book  stub  or  check 
register. 

The  auditor  should  bear  in  mind  that  the  majority  of  large  busi- 
ness houses  of  the  present  day  carry  accounts  with  two  or  more 

26 


banks,  making  it  necessary  for  him  to  secure  a  certificate  from  each 
one  setting  forth  the  information  above  specified  and  requiring  a 
reconciliation  of  the  balance  at  the  bank. 

TRIAL  BALANCE. 

Having  verified  the  balance  of  cash  on  hand,  petty  cash  and 
effected  a  reconciliation  of  the  bank  balance,  the  auditor  then  takes 
a  trial  balance  from  the  books  as  of  the  date  upon  which  the  audit 
period  closes.  If  a  trial  balance  is  already  taken  he  obtains  the 
same  result  by  checking  the  items  appearing  upon  it  with  the  bal- 
ance of  the  accounts  listed  to  prove  the  equilibrium  of  the  ledger. 

VERIFICATION  OF  FOOTINGS. 

It  is  the  duty  of  the  auditor  to  verify  the  footings  appearing 
in  all  books  of  record,  especially  those  records  involving  cash  trans- 
actions. In  conducting  an  audit  it  is  understood  that  the  auditor's 
:nvestigations  and  responsibilities  apply  wholly  within  the  period 
covered  by  the  audit  according  to  contract,  unless  the  condition  in 
which  he  finds  the  records  necessitates  his  investigating  previous 
records  for  the  purpose  of  arriving  at  the  proper  and  correct  results. 

In  verifying  the  footings  of  the  different  records,  such  as  the 
cash  book,  check  register,  journal,  purchase  record,  sales  record  or 
recapitulation,  bills  receivable  and  bills  payable  record,  etc.,  he  finds 
it  necessary  to  add  the  amounts  entered  in  the  special  columns  for 
each  month.  This  process  is  necessary  that  he  may  guarantee  that 
the  footings  as  shown  are  correct  and  that  the  bookkeeper  has  made 
no  errors  in  addition.  Further  reason  for  a  verification  of  the  foot- 
ings is  evidenced  by  an  explanation  of  a  verification  of  the  postings 
to  the  private  ledger.  Errors  frequently  occur  in  transferring  foot- 
ings from  one  page  to  another. 

VERIFICATION  OF  POSTINGS  TO  PRIVATE  LEDGER. 

The  private  and  general  ledger,  which  are  sometimes  identical, 
customarily  contain  controlling  accounts  with  cash,  purchase  ledger, 
sectionalized  sales  ledgers,  bills  receivable,  bills  payable,  personal 
accounts  with  officers,  salary  accounts,  expense  controlling  accounts, 
etc.  Postings  are  made  to  these  accounts  direct  from  the  footings 
of  the  special  columns  in  the  cash  book,  journal  and  purchase  and 
sales  records  monthly. 

27 


In  verifying  the  postings  to  the  private  ledger  the  auditor 
checks  the  amount  of  the  footings  of  the  special  columns  with  the 
entries  made  in  the  controlling  accounts.  He  first  verifies  the  post- 
ings from  the  cash  book,  which  are  usually  made  to  the  cash  account, 
interest  account,  discount  account,  bills  receivable  account,  accounts 
receivable  account,  etc.  He  then  verifies  the  postings  to  the  private 
ledger  accounts  from  the  check  register,  especially  postings  to  the 
bank  account,  discount  account,  interest  account,  bills  payable 
account,  accounts  payable  account,  etc.  He  then  verifies  the  post- 
lings  to  the  private  ledger  acounts  from  the  journal  covering  various 
sundry  and  nominal  accounts  used  when  making  cross,  adjusting 
and  closing  entries.  He  then  verifies  the  postings  as  made  from 
any  of  the  other  records,  such  as  purchases,  sales,  etc. 

It  is  readily  seen  that  his  work  thus  far  produces  the  follow- 
ing result:  A  verification  of  the  cash  on  hand,  petty  cash  and 
reconciliation  of  the  bank  account.  By  verifying  the  footings  of 
the  various  books  of  original  entry  and  checking  the  postings  of 
those  footings  to  the  respective  controlling  accounts  in  the  private 
ledger  he  knows  that  the  controlling  accounts  are  correct  except 
for  whatever  adjustment  may  be  necessary  when  his  work  of  check- 
ing progresses  and  the  audit  nears  completion. 

VERIFICATION  OF  TRIAL  BALANCE. 

In  verifying  the  footings  of  the  books  of  original  entry  and 
checking  postings  to  the  private  ledger  controlling  accounts  the 
auditor  may  find  errors  for  adjustment  or  he  may  find  the  work 
has  been  done  accurately.  However,  he  proceeds  to  verify  the  trial 
balance  taken  after  proving  the  cash  and  reconciling  the  bank  bal- 
ance. If  the  work  has  been  done  accurately  there  should  be  no 
difficulty  whatever  in  checking  up  the  trial  balance,  but  if  errors 
have  been  made  and  the  bookkeeper  has  forced  his  trial  balance  the 
auditor  makes  note  of  all  differences  that  they  may  be  properly 
adjusted,  so  that  his  final  report  may  contain  a  true  statement  of 
the  condition  of  the  business  upon  the  date  on  which  the  audit 
period  closes. 

It  is  sometimes  necessary  for  him  to  obtain  a  copy  oi  the  trial 
balance  for  the  fiscal  year,  or  other  business  period  immediately 
preceding  the  date  upon  which  his  audit  period  commences,  in  fact, 
this  is  oftentimes  essential  in  order  that  he  may  get  correct  results. 

28 


VERIFICATION  OF  POSTINGS— CASH  RECEIPTS. 

A  completed  audit  involves  a  careful  and  systematic  checking  of 
each  and  every  individual  cash  transaction  during  the  period  under 
audit.  The  cash  receipts  vary  in  nature  from  payments  of  subscrip- 
tions for  capital  stock  of  the  original  issue,  from  the  sales  of  treasury 
stock,  and  the  sale  of  capital  resources  to  the  regular  revenue  re- 
ceipts derived  from  the  sales  of  the  product  of  the  enterprise. 

If  the  stock  of  a  corporation  is  sold  above  par  the  company 
receives  actual  cash  in  excess  of  the  par  value  of  the  stock,  when 
the  premium  thus  obtained  is  not  considered  a  gain  of  the  business 
proper,  and  although  in  some  instances  it  is  carried  directly  to  profit 
and  loss  the  practice  in  this  respect  varies  considerably  in  the 
manner  of  conducting  the  accounts. 

If  the  business  under  audit  is  not  comparatively  new  and  has 
been  conducted  for  a  considerable  period  of  time  practically  all  of 
its  revenue  is  derived  from  the  sale  of  its  product  of  whatever  form. 
In  other  words,  practically  all  of  the  receipts  will  come  in  the  form 
of  remittances  from  customers,  therefore  but  very  few  postings  of 
individual  amounts  are  made  from  the  cash  book  direct  to  controll- 
ing accounts  in  the  private  ledger,  the  majority  of  all  individual 
postings  being  made  directly  to  accounts  with  customers  in  the 
sectionalized  sales  ledgers. 

Where  sectionalized  sales  ledgers  are  used  special  columns 
appear  on  the  debit  side  of  the  cash  book  to  permit  a  verification  of 
postings  to  each  ledger  separately.  In  a  complete  audit  the  auditor 
is  expected  to  check  each  individual  remittance  received  from  cus- 
tomers, from  sale  of  stock  or  property,  etc.,  to  the  account  in  the 
private  ledger  or  in  the  sectionalized  sales  ledger  to  which  it  is 
posted.  The  aggregate  of  all  postings  to  the  private  and  section- 
alized sales  ledgers  from  the  cash  book  should  agree  with  the  total 
cash  receipts  for  the  period  under  audit. 

A  question  immediately  arises  with  regard  to  the  manner  of 
making  postings  to  the  sales  ledger,  that  is,  if  the  amount  of  the 
remittance  is  posted  in  one  item  and  the  amount  of  the  discount 
upon  the  invoice  taken  by  the  customer  is  posted  in  another  item. 
It  is  recommended  that  the  posting  to  the  sales  ledger  account  shall 
be  an  amount  equal  to  the  sum  of  the  actual  remittance  received  plus 
the  discount  deducted,  in  which  case  the  aggregate  of  all  postings 
from  the  debit  side  of  the  cash  book  to  the  private  ledger  and  sec- 

29 


tionalized  sales  ledgers  should  agree  with  the  total  cash  receipts  as 
shown  by  the  cash  book  for  the  period  under  audit  plus  the  discounts 
allowed  to  customers  during  the  same  period. 

It  is  suggested  that  in  checking  the  work  the  auditor  use  some 
distinguished  check  mark  so  that  by  referring  to  an  account  in  any 
of  the  sectionalized  sales  ledgers  'he  can  readily  determine  whether 
a  posting  consists  of  cash  or  of  cash  and  discount,  also  that  the 
posting  is  made  from  the  cash  book,  as  distinguished  from  journal 
postings. 

The  auditor  should  always  recommend  to  any  company  that 
their  entire  cash  receipts  be  deposited  in  the  bank  and  that  all  dis- 
bursements of  whatever  nature  be  made  by  check,  even  those  made 
from  the  petty  cash,  a  voucher  being  drawn  for  the  original  sum. 
Where  this  system  is  used  the  total  cash  receipts  for  the  audit  period 
should  agree  with  the  total  deposits  for  the  same  period,  allowance 
being  made  for  cash  on  hand  at  the  commencement  of  the  period, 
also  at  the  end  of  the  period,  that  is,  the  cash  on  hand  at  the  com- 
mencement of  the  period  added  to  the  total  cash  receipts  during  the 
period,  less  cash  on  hand  at  the  close  of  the  period  should  agree 
with  the  total  deposits  shown  by  the  bank  pass  book  or  statement. 
This  plan  is  equally  simple  and  effective  whether  deposits  are  made 
in  one,  two  or  any  number  of  banks. 

VERIFICATION    OF    POSTINGS— CASH    DISBURSEMENTS. 

A  complete  audit  involves  a  careful  and  systematic  checking  of 
each  individual  transaction  involving  a  disbursement  of  cash.  The 
majority  of  business  houses  are  now  taking  advantage  of  the  sim- 
plicity, effectiveness  and  convenience  of  a  check  register  for  record- 
ing their  disbursements.  In  nearly  every  case  a  general  plan  is 
adopted  under  which  each  disbursement  is  made  by  check,  except  in 
the  case  of  sundry  disbursements  of  petty  cash  for  which  receipts 
are  taken. 

The  check  register  shows  upon  the  one  side  a  record  of  bank 
deposits  which  should  agree  with  the  record  of  deposits  entered  in 
the  bank  pass  book,  duplicate  deposit  tickets  or  statements,  and 
upon  the  other  side  a  record  of  all  checks  issued  listed  in  numerical 
order.  The  number  of  each  check  is  given,  in  whose  favor  it  is 
drawn  and  the  account  to  be  charged.  Charges  are  made  to  accounts 
payable  and  to  controlling  accounts  in  the  private  ledger,  as  well  as 

30 


personal  accounts  with  officers  on  account  of  salaries,  etc.  Postings 
to  accounts  payable  and  private  ledger  accounts  are  distinguished  by 
separate  columns.  Additional  columns  appear  in  which  to  enter  the 
amounts  of  discounts  upon  purchases. 

The  auditor  is  expected  to  check  each  individual  amount  posted 
to  the  accounts  payable  account  in  the  purchase  or  accounts  payable 
ledger.  In  checking  these  postings  he  should  use  some  distinguish- 
ing mark,  so  that  in  referring  to  the  accounts  payable  ledger  he  can 
readily  tell  which  of  the  debit  amounts  posted  to  an  account  repre- 
sent cash  payments  and  which  are  postings  from  the  journal  because 
of  any  adjustment  or  rebate  or  allowance  for  returned  goods. 

It  is  readily  seen  that  the  sum  total  of  all  of  the  postings  to  the 
accounts  payable  ledger  for  the  audit  period  should  agree  with  the 
total  cash  disbursements  to  creditors  whose  accounts  are  carried  in 
the  purchase  or  accounts  payable  ledger  for  the  same  period. 

The  question  immediately  arises  relative  to  discounts  earned. 
It  is  recommended  that  postings  to  the  purchase  ledger  be  made  in 
single  amounts,  that  is,  that  the  cash  disbursements  shall  not  be 
posted  separately  from  the  discounts  earned.  The  auditor  then  finds 
that  in  order  to  check  the  disbursements  he  must  effect  an  agree- 
ment between  the  accounts  payable  and  discount  column  in  the 
check  register  and  the  total  postings  therefrom  to  the  accounts  with 
creditors  in  the  purchase  or  accounts  payable  ledger. 

It  is  suggested  that  he  use  a  distinguishing  check  mark  for 
discriminating  between  postings  representing  cash  only  and  those 
made  up  of  cash  and  discount.  He  should  then  effect  an  agreement 
between  the  total  disbursements  posted  to  accounts  in  the  private 
ledger  and  the  amounts  posted  to  the  debit  side  of  the  private  ledger 
accounts  from  the  check  register.  After  verifying  all  of  the  postings 
from  the  check  register  to  the  accounts  payable  and  private  ledgers 
the  auditor  should  make  a  statement  for  his  own  information  show- 
ing that  the  total  disbursements  per  checks  issued  and  recorded  in 
the  check  register  during  the  audit  period  agree  with  the  total  post- 
ings to  cash  and  discount  to  the  accounts  payable  ledger  and  debit 
postings  from  the  check  register  to  the  accounts  in  the  private 
ledger. 

VERIFICATION  OF  PURCHASES  DISTRIBUTION. 

A  comprehensive  audit  involves  a  careful  and  systematic  check- 
ing of  each  and  every  invoice  received  by  the  business  for  goods 

31 


purchased  and  received  during  the  audit  period,  that  is,  each  invoice 
is  compared  with  the  entries  recorded  upon  the  purchase  record, 
journal  or  factory  voucher  register  in  order  that  the  auditor  may 
know  that  the  goods  covered  by  each  invoice  have  been  charged  to 
the  proper  accounts.  This  prevents  an  invoice  of  goods  covering 
sundry  supplies  of  an  expense  nature  being  charged  to  a  property  or 
asset  account,  or  vice  versa.  In  some  instances  the  purchase  invoices 
are  checked  against  the  original  purchase  orders  or  quotations,  but 
this  is  not  as  essential  as  checking  sales  invoices  against  the  shipping 
record. 

Where  a  large  number  of  invoices  are  received  daily,  weekly  or 
monthly  the  majority  of  business  houses  employ  a  system  of  number- 
ing in  numerical  sequence.  As  many  invoices  from  each  creditor  as 
can  be  conveniently  assembled  and  entered  upon  the  purchase  record 
are  numbered  in  order  before  recording.  When  the  invoices  are 
paid  they  are  usually  filed  either  by  number  or  by  the  name  of  the 
creditor.  If  by  number  it  is  a  comparatively  easy  matter  for  the 
auditor  to  check  the  invoices  against  the  purchase  record.  If  filed 
under  the  name  of  the  creditor  the  process  is  more  difficult,  although 
no  great  amount  of  time  is  lost  because  the  invoices  for  each  creditor 
are  filed  in  both  chronological  order  and  numerical  sequence. 

VERIFICATION  OF  POSTINGS— PURCHASE  INVOICES. 

When  the  auditor  has  completed  checking  the  invoices  against 
the  purchase  record  and  is,  therefore,  positive  that  the  amounts  of 
the  various  invoices  as  entered  upon  the  purchase  record  are  correct 
and  that  the  goods  covered  by  the  invoices  have  been  distributed  or 
charged  to  the  proper  accounts,  he  then  undertakes  a  careful  and 
systematic  checking  of  the  postings  from  the  purchase  record  to  the 
accounts  with  creditors  in  the  purchase  or  accounts  payable  ledger. 
When  he  has  checked  each  posting  to  the  credit  side  of  the  accounts 
payable  accounts  he  should  effect  an  agreement  between  the  total 
amount  of  all  of  the  invoices  recorded  in  the  purchase  record  during 
the  audit  period.  The  total  purchases  for  the  audit  period  as  shown 
are  a  credit  to  the  accounts  payable  controlling  account.  The  foot- 
ings of  the  special  columns  of  the  purchase  ledger  have  already  been 
verified,  as  well  as  the  postings  thereof  to  the  accounts  with  materials 
purchased,  which  are  sometimes  carried  in  a  separate  stores  ledger, 
although  frequently  made  a  part  of  the  purchase  ledger. 

32 


TRIAL  BALANCE  OF  PURCHASE  LEDGER  ACCOUNTS. 

The  progress  made  by  the  auditor  in  his  investigations  up  to 
this  point  has  involved  careful  and  systematic  checking  of  the  post- 
ings to  the  purchase  ledger  covering  invoices  credited  to  the  parties 
from  whom  the  goods  are  purchased,  postings  from  the  cash  book 
to  the  debit  side  of  accounts  with  creditors  covering  cash  disburse- 
ments and  discounts  earned  and  postings  from  the  journal  to  the 
debit  and  credit  sides  of  the  accounts  for  sundry  adjustments,  re- 
bates, allowances  for  returned  goods,  overcharges,  etc.  He  has  also 
verified  the  footings  in  the  check  register,  purchase  record  and 
journal,  as  well  as  having  made  a  verification  of  the  postings  from 
these  records  to  the  accounts  payable  controlling  account  in  the 
private  ledger. 

He  has  now  brought  his  work  up  to  the  point  where  he  is  in  a 
position  to  take  a  trial  balance  of  the  accounts  in  the  purchase  ledger 
to  effect  an  agreement  between  the  aggregate  balances  of  the  pur- 
chase ledger  accounts  and  the  balance  of  the  corresponding  accounts 
payable  controlling  account  in  the  private  ledger.  If  the  auditor  has 
done  his  work  thoroughly  and  accurately  the  agreement  mentioned 
should  readily  be  made,  taking  into  consideration,  of  course,  all 
notations  made  by  him  during  his  investigation  of  the  purchases 
and  cash  disbursements  for  errors,  etc.  In  other  words,  the  total 
credits  to  accounts  with  creditors  for  goods  purchased,  less  remit- 
tances made  to  them,  discounts  earned,  allowances  for  returned  goods 
or  deductions  of  any  other  nature  should  agree  with  the  balance  of 
the  accounts  payable  controlling  account,  which  shows  the  amount 
still  owing  to  creditors  for  goods  purchased. 

VERIFICATION  OF  SALES  CLASSIFICATION. 

In  fulfilling  his  responsibilities  under  a  complete  audit  the 
auditor  is  expected  to  carefully  and  systematically  check  each  invoice 
rendered  to  customers  for  goods  sold,  making  comparison  of  the 
amount  appearing  upon  the  manifold  copy  of  the  invoice  or  other 
form  of  copy  with  the  corresponding  amount  entered  upon  the  sales 
recapitulation  sheet.  Another  very  important  matter  is  the  check- 
ing of  sales  invoices  against  the  shipping  record  to  make  certain 
that  no  goods  have  been  shipped  out  without  proper  invoice  having 
been  rendered  therefor. 

33 


The  majority  of  business  houses  now  use  the  manifold  billing 
system  and  the  auditor  will  invariably  find  the  manifold  copies  of 
the  invoice  in  a  binder  arranged  in  chronological  and  numerical 
order.  If  a  recapitulation  has  not  been  made  the  auditor  should  pro- 
ceed to  make  a  recapitulation  of  the  sales  for  the  entire  audit  period 
upon  a  monthly  basis.  It  is  not  considered  the  duty  of  the  auditor 
to  make  a  comprehensive  analysis  of  the  sales  according  to  their 
nature,  although  if  the  business  is  using  a  sales  recapitulation  which 
shows  a  classification  of  sales  and  this  classification  is  to  have  any 
important  bearing  upon  the  final  statements  to  be  prepared  and  sub- 
mitted by  the  auditor  then  he  should  check  the  sales  invoices  with 
the  recapitulation  sheets  for  the  purpose  of  not  only  verifying  the 
amount  of  the  invoices  proper,  but  for  verifying  the  classification  or 
distribution. 

Upon  completion  of  the  recapitulation  of  sales  by  months  the 
auditor  should  verify  the  postings  of  the  amount  of  sales  for  the 
various  months  with  the  corresponding  amounts  entered  to  the  debit 
of  the  accounts  receivable  controlling  account  in  the  private  ledger. 
The  amount  is  also  credited  to  an  account  with  sales. 

VERIFICATION  OF  POSTINGS— SALES  INVOICES. 

A  comprehensive  audit  involves  a  careful  and  systematic  check- 
ing of  the  amounts  of  all  invoices  as  entered  upon  the  recapitulation 
of  sales  for  the  different  months,  the  corresponding  amounts  posted 
to  the  debit  of  the  accounts  receivable  accounts  in  the  sectionalized 
ledgers. 

Where  sectionalized  ledgers  are  used  the  sales  recapitulation 
contains  special  columns  corresponding  with  the  different  sales 
ledgers  in  order  that  postings  to  each  ledger  may  be  proven  separ- 
ately. When  the  auditor  has  checked  each  indiviuai  posting  from 
the  recapitulation  of  sales  to  the  accounts  in  the  sales  ledgers  he 
should  then  effect  an  agreement  between  the  total  sales  for  the  audit 
period,  the  customers  whose  accounts  are  carried  in  one  of  the  sales 
ledgers  and  the  total  debit  postings  to  their  accounts  from  the  sales 
record.  The  same  agreement  is  effected  in  the  same  manner  for 
each  of  the  sectionaldzed  sales  ledgers,  while  the  aggregate  sales 
of  the  entire  business  for  the  audit  period  should  agree  with  the 
aggregate  of  all  sales  postings  to  customers'  accounts  for  all  of  the 
sales  ledgers  for  the  same  period. 

34 


It  is  suggested  that  the  auditor  should  use  some  distinguishing 
check  mark  when  verifying  postings  from  the  sales  records  to  the 
accounts  receivable  accounts  that  he  may  know  in  referring  to  the 
sales  ledger  which  of  the  debit  postings  are  made  from  the  sales 
records  and  which  come  from  the  journal  because  of  any  adjustment. 

TRIAL  BALANCE  OF  SALES  LEDGER  ACCOUNTS. 

The  progress  of  the  auditor  in  making  his  investigation  up  to 
this  point  has  involved  a  careful  and  systematic  checking  of  the 
postings  to  the  accounts  receivable  accounts  from  the  sales  recapitu- 
lation, from  the  cash  book  showing  credits  for  cash  remittances 
received  and  discounts  allowed,  and  from  the  journal  for  returned 
goods,  allowances,  rebates  and  adjustments.  The  footings  of  the 
various  records  affecting  sales  have  been  verified  and  a  verification 
of  postings  of  these  amounts  to  the  controlling  accounts  in  the 
private  ledger  completed. 

He  is  now  in  a  position  to  take  a  trial  balance  of  the  sales 
ledger  accounts  to  see  if  the  aggregate  of  the  balances  of  the  accounts 
receivable  in  the  sales  ledger  agree  with  the  aggregate  balance  of 
the  corresponding  sales  ledger  controlling  account  in  the  private 
ledger.  If  he  has  done  his  work  thoroughly  and  accurately  he  should 
have  no  difficulty  in  effecting  this  agreement,  taking  into  considera- 
tion, of  course,  all  notations  made  by  him  for  errors  discovered 
during  his  investigation.  In  other  words,  the  total  debits  to  cus- 
tomers for  goods  sold,  less  cash  remittances  received  from  them, 
discounts  allowed,  allowance  for  returned  goods  and  other  deduc- 
tions of  whatever  nature,  should  agree  with  the  balance  of  the  sales 
ledger  controlling  account  which  shows  the  amount  the  customers 
still  owe  for  goods  furnished. 

VERIFICATION  OF  INVOICES  WITH   SHIPMENTS. 

There  is  one  opportunity  in  connection  with  an  audit  outside 
of  the  verification  of  cash  where  the  auditor  may  prove  his  services 
to  the  company  worth  many  times  the  amount  he  is  to  receive  for 
his  work  according  to  his  contract.  This  opportunity  lies  in  a  com- 
parison of  the  record  of  shipments  with  the  invoices  rendered. 

It  is  not  unusual  for  an  auditor  to  discover  shipments  made  to 
customers  for  which  no  bill  is  rendered.  To  prevent  the  shipment 
of  goods  without  proper  invoicing  the  auditor  should  carefully  and 

35 


systematically  check  each  invoice  rendered  during  the  audit  period 
against  the  copy  of  the  confirmation  of  the  order  mailed  to  the 
customer  when  his  order  is  received. 

In  the  majority  of  businesses  at  the  present  time  there  is  an 
established  custom  of  confirming  or  acknowledging  orders  for  goods, 
the  confirmation  or  acknowledgment  also  stating  when  delivery  may 
be  expected.  It  is  against  this  acknowledgment  or  confirmation  that 
the  auditor  checks  the  invoice.  Wherever  a  system  of  acknowledg- 
ments or  confirmations  is  not  used  the  business  invariably  uses  a 
manifold  system  of  recording  shipments,  that  is,  whenever  a  ship- 
ment of  goods  is  made  to  a  customer  a  number  is  assigned  to  the 
shipment  and  a  list  of  all  of  the  goods  contained  in  the  shipment 
stated  upon  this  shipping  record.  The  manifold  blanks  bear  con- 
secutive numbering. 

Where  this  system  is  employed  and  proper  discretion  used  it  is 
practically  impossible  for  the  shipping  department  to  ship  out  a  bill 
of  goods  without  making  a  proper  shipping  record  therefor.  The 
auditor  obtains  satisfactory  results  by  making  a  comparison  of  the 
sales  invoice  rendered  with  this  manifold  shipping  record.  In  other 
words,  his  audit  of  this  particular  item  for  investigation  involves 
checking  the  sales  invoice  against  the  acknowledgment  or  confirma- 
tion of  the  order  or  the  manifold  copy  of  the  shipping  record. 

TRIAL  BALANCES   OF  SUBSIDIARY  LEDGERS. 

Not  infrequently  the  auditor  will  find  in  use  several  subsidiary 
ledgers  in  addition  to  the  purchase,  sales  and  private  ledgers,  con- 
trolling accounts  with  which  will  be  carried  in  the  latter.  After 
proper  verification  of  the  footings  and  postings  to  the  various 
accounts  in  the  subsidiary  ledger  the  auditor  then  proceeds  to  take 
a  trial  balance  of  the  accounts  in  each  subsidiary  ledger  to  effect  an 
agreement  between  the  aggregate  balances  of  such  accounts  and  the 
balance  of  the  corresponding  controlling  account  in  the  private 
ledger.  The  same  method  is  followed  out  as  outlined  for  taking  a 
trial  balance  from  the  purchase  and  sales  ledgers. 

VERIFICATION  OF  INVENTORY. 

In  order  that  the  work  of  the  auditor  may  be  accurate  and  thor- 
ough it  is  necessary  that  he  be  given  an  opportunity  to  audit  the 
record  of  the  inventory  taken  at  the  close  of  the  period  under  audit. 

36 


He  should  also  have  a  record  of  the  inventory  taken  at  the  com- 
mencement of  the  period  under  audit.  It  is  regarded  as  the  duty  of 
the  auditor  to  verify  the  inventory  extensions.  He  should  also 
inspect  the  stock  listed  on  the  inventory  record  to  see  that  the  values 
are  not  fictitious  or  inflated,  briefly,  to  satisfy  himself  beyond  all 
reasonable  doubt  that  the  inventory  as  furnished  to  him  is  approxi- 
mately correct. 

The  inventory  audit  should  not  only  call  for  a  thorough  inven- 
tory record,  a  verification  of  extensions,  a  footing  of  the  entire 
inventory,  an  inspection  of  the  stock,  a  verification  of  quantities 
wherever  possible,  but  a  careful  comparison  of  the  prices  of  the 
various  articles  as  listed  upon  the  inventory  with  the  prices  paid 
for  those  articles  by  the  company,  according  to  purchase  invoices 
covering  the  same.  This  comparison  of  the  inventory  prices  with 
the  prices  upon  the  original  invoices  should  convince  the  auditor 
that  the  inventory  as  calculated  contains  no  fictitious  or  inflated 
prices. 

Notwithstanding  this  opportunity  for  verifying  the  inventory  it 
is  considered  an  excellent  policy  for  the  auditor  to  secure  from  the 
secretary  of  the  company,  or  from  some  other  official  with  proper 
authority,  a  certificate  specifically  stating  that  the  prices  used  in 
making  the  inventory  calculations  are  correct.  Such  a  certificate 
shifts  the  responsibility  of  the  values  shown  from  the  auditor  to  the 
company  itself,  while  the  auditor's  responsibility  lies  in  a  correct 
calculation  of  the  extensions  and  verification  of  the  total. 

Even  though  the  certificate  mentioned  is  secured  it  is  not  suf- 
ficient reason  to  cause  the  auditor  to  neglect  a  thorough  investiga- 
tion of  the  inventory,  as  there  are  many  instances  where  the  secre- 
tary or  other  official  has  certified  to  incorrect  valuations,  in  conse- 
quence of  which  the  final  report  prepared  and  submitted  by  the 
auditor  to  the  board  of  directors  has  been  inaccurate  and  misleading. 

AUDITING  PAY  ROLL. 

The  exact  nature  of  the  pay  roll  audit  depends  largely  upon 
the  agreements  set  forth  in  the  auditor's  contract  pertaining  thereto. 
Where  no  special  stipulations  are  made  it  is  customarily  understood 
that  the  pay  roll  audit  consists  in  a  verification  of  the  labor  expen- 
diture for  the  last  pay  roll  date.  The  auditor  calls  for  the  last  com- 
plete pay  roll  and  checks  the  time  clock  cards  of  the  various  work- 

37 


men  employed  upon  a  day  wage  basis  against  the  entries  recorded 
upon  the  pay  roll  record.  Piece  workers  are  usually  required  to  sign 
proper  receipts  for  their  pay  which  they  are  obliged  to  surrender 
before  their  envelope  is  handed  to  them.  These  receipts  are  checked 
against  the  pay  roll  record  for  verifying  the  labor  expenditure  for 
piece  workers;  employes  working  under  bonus  systems  and  profit 
sharing  plans,  etc.  Briefly  stated,  a  verification  of  the  last  pay  roll 
preceding  the  date  upon  which  the  audit  under  consideration  closes 
consists  of  checking  bona  fide  receipts  of  the  employes  against  the 
entries  recorded  upon  the  pay  roll  record.  The  auditor  is  expected 
to  exercise  reasonable  care  and  judgment  to  detect  "dead  men" 
sometimes  carried  upon  pay  rolls,  and  to  conduct  his  investigation 
in  such  a  manner  that  he  can  certify  that  a  proper  receipt  has  been 
taken  from  each  workman  for  the  money  paid  out,  and  that  the  re- 
ceipts examined  and  approved  are  genuine.  Absolute  certainty  in 
this  respect  guarantees  proper  voucher  for  the  pay  roll  expenditure, 
preventing  the  carrying  of  fictitious  names  upon  the  records  and  the 
falsification  of  receipts. 

In  some  instances  the  auditor's  contract  calls  for  a  comprehen- 
sive investigation  of  all  the  pay  rolls  during  the  period  under  audit 
and  an  exhaustive  analysis  of  the  labor  expenditure.  The  process 
of  verification  follows  closely  the  outline  used  for  checking  up  the 
last  pay  roll,  it  being  understood  that  the  auditor  pays  no  attention 
to  accuracy  of  the  pay  roll  calculations  with  respect  to  the  hours, 
rates  and  amounts  or  in  piece  work  the  number  of  pieces  and  rates 
per  piece  or  bonuses  and  division  of  profits,  it  is  considered  suffici- 
ent for  him  to  merely  verify  the  entries  upon  the  pay  roll  record. 

A  proper  analysis  of  the  labor  expenditure  consists  in  its  class- 
ification under  the  headings,  Productive,  Non-Productive,  Construc- 
tion, Maintenance,  Experimental,  etc.,  as  well  as  a  departmental 
distribution.  In  a  completed  audit  it  is  seldom  that  any  attention 
is  given  to  any  of  the  pay  rolls  except  the  last  and  usually  a  labor 
analysis  is  not  required.  It  is  well  for  the  auditor  to  carefully 
glance  through  the  preceding  pay  rolls  as  he  might  notice  some  irreg- 
ularity which  would  form  the  basis  of  comment  in  his  final  report. 
The  permanent  auditor  employed  by  a  business  for  making  a  con- 
tinuous audit  is  expected  to  have  all  pay  roll  expenditures  properly 
vouched  for  by  genuine  receipts  and  to  make  a  proper  analysis  and 
classification  departmentally  and  under  the  headings  above  men- 
tioned. 

38 


STATEMENT  OF  BILLS  RECEIVABLE. 

In  many  lines  of  business  the  bills  receivable  controlling  ac- 
count in  the  private  ledger  requires  considerable  time  for  its  proper 
analysis.  The  balance  of  this  account  represents  the  amount  of  bills 
receivable  held  by  a  business,  and  in  this  connection  the  auditor 
should  exercise  his  best  judgment  in  determining  the  extent  of  the 
liability  of  the  business  for  bills  receivable  discounted,  deposited  as 
collateral  security,  etc.  It  has  already  been  stated  that  he  requests 
of  each  bank  with  whom  accounts  are  carried  statements  showing 
the  contingent  liability  of  the  business  for  notes  discounted,  still 
unpaid. 

The  statement  of  bills  receivable  as  prepared  by  the  auditor 
shows  a  history  of  each  note,  proper  calculations  being  made  for  in- 
terest accumulations.  Each  note  is  usually  assigned  a  number  as 
a  means  of  identification.  The  auditor's  statement  shows  the  num- 
ber, date  of  the  paper,  name  of  the  maker  with  address,  where  it  is 
made  payable,  the  names  and  addresses  of  any  endorsers,  length  of 
time  the  note  is  to  run,  date  upon  which  it  matures,  amount  of  the 
note,  if  interest  bearing  the  rate  per  cent,  the  amount  of  accrued 
interest  and  any  other  information  of  a  special  nature.  Occasionally 
the  auditor  finds  that  some  of  the  notes  have  already  been  forwarded 
for  collection  and  he  includes  these  in  his  report  with  proper  nota- 
tion, his  record  thereof  being  made  as  complete  as  possible  from 
information  recorded  upon  the  bills  receivable  record. 

He  may  also  discover  that  some  of  the  notes  have  been  depos- 
ited as  collateral  security,  and  that  bills  payable  have  been  issued 
for  the  money  borrowed  upon  them.  Unless  the  interest  has  been 
paid  in  advance  upon  the  money  borrowed  he  will  have  to  calculate 
the  accrued  interest  due  the  bank,  if  it  has  been  paid  in  advance 
there  may  be  quite  an  item  of  interest  paid  but  unearned.  Separate 
statements  are  prepared  for  bills  receivable  current  and  bills  receiv- 
able past  due.  When  the  auditor's  statements  are  complete  the 
total  amount  of  bills  receivable  current  added  to  the  bills  receiv- 
able past  due  as  shown  thereon  should  agree  with  the  balance  of 
the  bills  receivable  controlling  account  in  the  private  ledger. 

STATEMENT  OF  BILLS  PAYABLE. 

The  balance  of  the  bills  payable  controlling  account  in  the 
private  ledger  shows  the  amount  of  bills  payable  issued  by  a  busi- 

39 


ness  outstanding  and  unpaid.  In  presenting  a  statement  of  bills 
payable  the  auditor  shows  the  number,  date  of  the  paper,  name  of 
the  payee  with  address,  where  it  is  made  payable,  name  of  endorsers 
if  any,  length  of  time  it  is  to  run,  date  of  maturity,  amount  of  note, 
rate  per  cent  of  interest  if  interest  bearing,  the  amount  of  accrued 
interest  and  any  other  special  information.  When  his  statement  is 
completed  the  total  amount  of  bills  payable  outstanding  as  shown 
therein  agrees  with  the  balance  of  the  bills  payable  controlling 
account  in  the  private  ledger.  Proper  mention  should  be  made  of 
accumulated  interest  due  and  the  amount  incorporated  in  the  bal- 
ance sheet  as  a  liability  of  the  business. 

EXHIBIT  OF  LAST  OFFICE  PAY  ROLL. 

The  auditor  incorporates  in  his  statements  a  copy  of  the  last 
office  pay  roll  for  the  purpose  of  showing  the  amounts  of  the  sal- 
aries drawn  by  the  officers  of  the  company,  the  manager,  superin- 
tendent, and  other  officials  engaged  in  the  administration  of  the  com- 
pany's affairs. 

Access  is  permitted  to  the  record  of  minutes  of  the  meetings 
of  the  directors,  and  the  auditor  should  peruse  these  carefully  to 
ascertain  that  the  salaries  drawn  by  the  officers  are  authorized  by  a 
vote  or  by  votes  of  the  Board  of  Directors.  In  the  event  of  any 
officer  drawing  a  salary  more  than  the  sum  authorized  for  payment 
proper  comment  should  be  made. 

TRIAL  BALANCE  FROM  STOCK  LEDGER. 

The  stock  ledger  shares  minute  investigation  with  all  of  the 
other  important  records  of  a  corporation  during  the  auditor's  work. 
In  the  majority  of  instances  even  the  smallest  corporation  will  keep 
a  stock  or  shareholders'  ledger  containing  accounts  with  stockhold- 
ers. Where  a  separate  ledger  is  not  used  for  this  purpose  the  ledger 
record  usually  appears  in  a  standard  form  of  corporation  record 
commonly  used  by  small  corporations.  A  corporation  record  gen- 
erally contains  blank  records  of  minutes  of  the  first  meeting  of  the 
stockholders,  first  meeting  of  the  directors,  by-laws,  regular  meetings 
of  stockholders  and  directors,  stock  subscription  register,  stock  led- 
ger of  original  certificates  issued,  stock  ledger  of  re-issue  certificates, 
dividend  register,  stock  certificate  transfer  register,  etc.,  etc. 

A  separate  stock  ledger  as  used  for  large  corporations  having 

40 


several  thousand  stockholders  is  balanced  in  the  same  manner  as  the 
ledger  section  of  a  corporation  record.  An  account  is  carried  in  the 
ledger  with  each  stockholder  showing  the  number  of  shares  of  stock 
of  record  upon  the  books  of  the  corporation  issued  in  the  name  of 
the  stockholder.  The  account  is  debited  with  the  number  of  shares 
held  and  credited  with  the  number  of  shares  sold  or  transferred  to 
any  one  else.  Postings  to  the  debit  side  of  the  accounts  are  made 
direct  from  the  stubs  of  the  stock  certificate  books.  On  the  credit 
side  of  the  stock  ledger  appears  a  credit  to  an  account  with  capital 
stock  which  represents  the  total  number  of  shares  of  authorized  cap- 
ital. If  all  of  the  stock  is  subscribed  and  issued,  the  sum  total  of 
all  debits  to  the  accounts  with  stockholders  agrees  with  the  credit 
to  the  capital  stock  account.  In  the  event  of  only  a  part  of  the  stock 
being  subscribed  and  issued  leaving  a  balance  of  shares  in  the 
treasury  a  debit  to  an  account  with  treasury  stock  appears  in  the 
stock  ledger,  then  the  number  of  treasury  shares  must  be  added  to 
the  total  shares  debited  to  the  stockholders  in  order  to  effect  a 
trial  balance  of  the  stock  ledger. 

It  is  explained  that  postings  to  the  stockholders  accounts  are 
made  from  the  stubs  of  the  stock  certificate  book.  Upon  the  can- 
cellation of  any  certificate  for  the  transfer  of  stock  a  new  certificate 
is  issued  in  its  place,  the  old  certificate  being  attached  or  pasted  to 
the  original  stub  from  which  it  was  detached.  Thus  it  is  seen  that 
the  total  number  of  shares  as  represented  by  the  sum  of  all  shares 
shown  upon  the  stock  certificate  stubs  from  which  the  certificates 
have  been  detached  and  issued  agrees  with  the  total  shares  outstand- 
ing as  shown  by  the  total  debits  to  accounts  with  stockholders  in 
the  stock  ledger.  It  is  regarded  the  duty  of  the  auditor  to  check 
the  number  of  shares  as  shown  upon  these  stubs  against  the  corre- 
sponding entries  upon  the  ledger.  In  a  measure  this  prevents  the 
issue  of  shares  in  excess  of  the  authorized  capitalization.  Proper 
investigation  of  the  dividend  account  and  preparation  of  the  divi- 
dend statement  coupled  with  the  trial  balance  taken  from  the  stock 
ledger  is  considered  sufficient  evidence  that  the  accounts  with  shares 
of  capital  stock  are  regular. 

VERIFYING  DIVIDEND  ACCOUNT. 

The  auditor  is  expected  to  check  the  dividend  account  and  pre- 
sent a  statement  in  detail  of  all  dividends  declared  and  paid  during 
the  period  covered  by  the  audit.  His  statement  shows  the  number 

41 


of  shares  of  stock  outstanding  and  the  dividend  rate  percent  as  well 
as  the  amount  of  the  total  dividends  paid.  Special  dividend  checks 
are  generally  use  instead  of  the  regular  check  of  the  corporation. 
Each  dividend  declared  is  assigned  a  number  consecutively,  there 
being  printed  upon  the  special  checks  the  following:  "Dividend  No. 
21"  etc.  The  auditor  should  total  all  checks  for  each  dividend  to 
make  certain  that  the  dividend  actually  paid  corresponds  with  the 
entries  appearing  upon  the  records  and  to  verify  the  amount  of  out- 
standing dividend  checks  unpaid,  if  any,  which  are  liabilities  of  the 
business. 

A  proper  audit  of  the  business  will  serve  to  safeguard  the  in- 
terests of  the  business  against  any  dividend  being  declared  out  of 
capital  instead  of  earnings.  The  latter  procedure  is  illegal,  and  the 
directors  may  personally  be  held  liable  for  any  dividend  so  declared 
since  they  are  expected  to  pursue  a  reasonable  and  proper  course  to 
ascertain  if  sufficient  actual  profit  has  been  made  to  warrant  a  divi- 
dend before  passing  a  resolution  declaring  one  and  authorizing  the 
treasurer  to  pay  the  same  out  of  the  funds  of  the  company. 

TRIAL  BALANCE  FROM  PRIVATE  LEDGER. 

After  having  carefully  carried  out  the  plan  of  auditing  outlined 
in  the  preceding  pages  the  auditor  will  have  practically  completed 
his  work  of  investigation  and  be  prepared  to  present  accurate  state- 
ments showing  the  actual  condition  of  the  affairs  of  the  company 
and  make  such  recommendations  as  in  his  best  judgment  he  deems 
advisable  and  necessary  for  simplifying  the  methods  of  handling  the 
work  and  making  more  efficient  the  accounting  records. 

The  first  step  is  the  taking  of  a  trial  balance  from  the  private 
ledger  after  all  accounts  therein  have  been  properly  investigated, 
and  their  accuracy  proven.  The  details  of  this  trial  balance  will 
vary  according  to  the  custom  of  the  management  in  keeping  their 
private  ledger.  Custom  now  prevails  making  it  advisable  to  carry 
in  the  private  ledger  controlling  accounts  with  the  subsidiary  led- 
gers, sales,  purchases,  expenses,  etc.,  and  in  some  instances  a  con- 
trolling account  with  what  is  termed  a  General  Ledger,  although 
the  latter  is  frequently  identical  with  the  private  ledger. 

ADJUSTING  ENTRIES. 

A  few  words  of  explanation  regarding  adjusting  entries  may 
serve  to  aid  in  giving  an  exact  outline  of  the  duties  of  the  auditor. 

42 


As  the  work  progresses  he  finds  errors  in  addition,  postings  made  to 
wrong  accounts,  incorrect  distribution  of  purchases  or  analysis  of 
sales,  etc.  It  is  evident  that  where  numerous  errors  occur  the  books, 
even  though  they  are  in  balance,  do  not  present  a  correct  record  of 
the  transactions  made,  nor  does  the  balance  sheet  exhibit  a  true 
condition  of  the  affairs  of  the  company.  As  each  error  is  discovered 
the  auditor  makes  a  correcting  journal  entry  giving  an  explanation 
and  referring  to  the  record  and  page  upon  which  it  occurs.  If  a 
very  extensive  audit  is  undertaken  and  the  books  have  been  kept 
by  an  incompetent  individual  it  is  not  uncommon  for  the  auditor  to 
discover  scores  of  errors,  and  in  some  instances  they  have  been 
known  to  number  into  the  hundreds. 

Although  the  auditor  submits  with  his  final  report  a  list  of  all 
adjusting  entries  necessary  to  place  the  books  in  proper  shape  he  is 
not  expected  to  actually  make  the  entries  upon  the  books.  This  is 
left  to  the  individual  responsible  for  their  proper  keeping.  However, 
in  presenting  trading  and  profit  and  loss  statements  and  a  balance 
sheet  he  must  take  into  consideration  all  adjustments  covered  by 
the  entries,  otherwise  'his  final  statement  would  not  be  correct.  It 
is  suggested  that  the  auditor  make  considerable  comment  upon  the 
adjusting  entries,  if  they  are  numerous,  and  in  any  event  give  them 
the  attention  in  his  report  which  they  deserve.  His  comment  should 
not  only  cover  the  extent  of  the  errors  discovered,  but  the  nature 
of  them  as  well.  Some  of  them  may  have  been  committed  inten- 
tionally, while  others  were  due  to  negligence,  carelessness  or  proper 
lack  of  interest  in  the  work. 

There  is  one  criticism  which  may  be  made  by  the  auditor  affect- 
ing arbitrary  entries.  Often  times  a  book-keeper  during  the  course 
of  his  work  will  discover  that  he  has  posted  an  item  to  the  wrong 
account,  and  to  correct  the  matter,  merely  makes  a  posting  of  the 
same  amount  under  the  same  date  on  the  opposite  side  of  the  ac- 
count and  then  posts  the  item  to  the  proper  side  of  the  right  account 
without  going  to  what  he  may  consider  the  "trouble"  of  making  a 
cross  entry  in  'his  journal.  It  is  one  of  the  first  principles  of  account- 
ing that  no  entry  shall  be  posted  upon  any  record  except  from  some 
record  of  original  entry.  Arbitrary  entries  result  in  endless  con- 
fusion making  it  almost  impossible  for  an  auditor,  or  anyone  else, 
to  affect  an  agreement  between  sales  and  postings  to  accounts  with 
customers  in  sectionalized  sales  ledgers,  etc. 

43 


PRESENTATION  OF  TRADING  STATEMENT. 

A  trading  statement  is  prepared  in  the  proper  manner  for  the 
purpose  of  showing  the  gross  profit  of  the  business  for  the  audit 
period.  The  preparation  of  a  trading  statement  involves  an  exact 
knowledge  of  the  following  facts : 

Amount  of  inventory  at  commencement  of  audit  period. 

Purchases  made  during  the  period  less  all  returns  and  al- 
lowances of  any  nature. 

Productive  labor. 

Manufacturing  and  other  trading  expenses. 

In-freight  and  drayage. 

Proportion  team  expense  for  hauling  goods  purchased. 

Sales  made  during  period  covered  by  the  audit  less  returns 
and  allowances  of  any  nature. 

Amount  of  inventory  at  close  of  the  period. 

In  speaking  of  "sales"  it  is  understood  that  this  item  covers 
the  sales  properly  invoiced  and  charged  to  customers,  orders  on  hand 
unfilled  are  not  included. 

After  determining  the  amount  of  the  gross  profit  for  the  period, 
which  is  the  difference  between  the  net  sales  and  the  cost  of  getting 
the  goods  into  a  marketable  condition,  the  auditor  should  calculate 
the  ratio  of  percentage  between  the  gross  profit  and  the  net  sales. 
That  is,  if  the  gross  profit  is  $10,000  and  the  sales  amount  to  $100,- 
000,  the  ratio  is  a  ten  percent  profit  on  the  net  sales.  He  then  estab- 
lishes in  similar  manner  a  ratio  between  the  gross  profit  and  the 
turnover,  a  term  used  to  represent  the  cost  of  getting  the  goods  into 
a  marketable  condition.  It  is  unnecessary  to  prepare  a  statement  of 
turnover  as  the  trading  statement  suffices  although  if  such  a  state- 
ment was  shown  it  would  be  found  that  the  amount  of  gross  profit 
shown  therein  would  agree  with  the  amount  appearing  upon  the 
trading  statement. 

Whether  or  not  the  auditor  shall  prepare  departmental  trading 
statements  depends  entirely  upon  the  conditions  of  his  contract  with 
the  company  covering  the  audit  although  when  not  specified  a  gen- 
eral trading  statement  is  considered  sufficient. 

44 


PRESENTATION  OF  PROFIT  AND  LOSS  STATEMENT. 

In  the  preparation  of  the  profit  and  loss  statement  the  gross 
profit  from  the  trading  account  is  brought  down  to  the  credit  side  of 
the  profit  and  loss  statement  and  all  expenses  including  general 
office  expenses,  managerial  expenses,  selling  expenses,  etc.,  are  en- 
tered upon  the  debit  side,  the  difference  between  the  two  sides  of  the 
statement  then  shows  the  net  profit  or  loss.  If  the  expenses  exceed 
the  gross  profits  the  difference  is  a  loss,  if  the  gross  profits  exceed 
the  expenses,  then  the  difference  is  net  profit. 

In  a  profit  and  loss  statement  it  is  desirable  to  classify  the  sell- 
ing expenses  and  the  administrative  or  general  expenses,  showing 
the  amount  of  each  classification  separately,  as  the  totals  are  fre- 
quently used  in  preparing  the  statistical  statements.  Selling  expense 
might  be  pro-rated  over  sales,  but  this  involves  considerable  labor 
and  does  not  result  in  any  particular  benefit.  A  comparative  state- 
ment of  sales  and  selling  expenses  is  desirable  in  order  that  an  abso- 
lute check  may  be  provided  upon  an  abnormal  increase  in  the  selling 
expenses.  A  departmental  profit  and  loss  statement  clearly  exhibits 
the  net  profit  or  loss  of  each  department  of  the  business  or  each  line 
of  goods  handled. 

The  profit  and  loss  statement  contains  numerous  items  of  ac- 
crued liabilities  or  floating  assets,  as  later  explained  in  connection 
with  the  preparation  of  the  balance  sheet. 

All  journal  adjusting  entries,  made  by  the  auditor,  are  taken  into 
consideration  prior  to  presenting  the  trading  and  profit  and  loss  state- 
ment and  balance  sheet.  Trading  and  profit  and  loss  statements  con- 
tain valuable  information  which  is  used  by  the  auditor  in  preparing 
comparative  statistics. 

There  are  various  lines  of  business  in  which  it  is  practically  im- 
possible for  the  auditor  to  establish  a  unit  of  production  unless  the 
audit  is  very  broad  and  far  reaching  in  its  scope,  involving  the  most 
detailed  examination  and  the  preparing  of  departmental  or  classified 
statements,  balance  sheets,  etc.  Many  lines  of  business  have  a  stand- 
ard unit  of  production,  such  as  a  barrel  of  beer  in  the  brewery  busi- 
ness, barrels  of  flour  in  the  flour  milling  enterprise,  an  automobile  in 
the  automobile  industry,  etc. 

Perhaps  the  most  valuable  information  embodied  by  the  auditor 
in  his  report  is  a  table  of  correct  percentages  for  the  important  items 

45 


under  consideration  calculating  upon  a  basis  of  a  unit  of  production. 
There  are  few  instances  where  a  manufacturing  enterprise  does  not 
keep  an  accurate  record  of  their  units  of  production,  a  brewery  al- 
ways maintains  a  record  of  the  number  of  barrels  of  beer  brewed 
during  any  given  time,  while  similar  information  is  generally  at  hand 
for  all  other  lines  of  commercial  endeavor.  The  auditor  accurately 
establishes  figures  showing  the  total  output  of  the  business  during 
the  period  covered  by  his  audit. 

Assuming  that  a  brewery  has  an  output  of  50,000  barrels  during 
the  audit  period  and  that  the  profit  and  loss  statement,  prepared  by 
the  auditor,  shows  the  total  expenses  at  $12,500,  it  is  very  evident 
that  the  average  cost  per  barrel  is  twenty-five  cents.  This  does  not 
include  the  cost  of  material,  manufacturing  and  trading  expenses. 
He  then  establishes  the  average  selling  price  per  unit  by  dividing 
the  net  sales  for  the  period  by  the  actual  number  of  units  sold.  Sim- 
ilar calculations  are  made  showing  the  exact  amount  of  operating 
expenses  for  each  unit  of  production.  In  some  lines  of  business  all 
manufacturing  and  trading  expenses  are  designated  Operating  Ex- 
penses, whereas  this  term  is  also  used  in  a  much  broader  sense  in 
some  instances,  covering  not  only  cost  of  maintenance,  repairs,  man- 
ufacturing and  trading  expenses,  but  administrative  expenses,  etc. 

The  auditor  may  arrange  his  calculations  so  as  to  effect  an 
agreement  among  the  following  items,  using  as  a  basis  for  his  cal- 
culations the  unit  of  production :  The  average  net  selling  price  per 
unit  minus  the  average  cost  per  unit  gives  the  average  net  profit  per 
unit.  In  further  consideration  of  these  three  items,  the  average  net 
selling  price  per  unit  multiplied  by  the  number  of  units  sold  gives 
the  net  sales  for  the  period,  the  average  cost  per  unit  multiplied  by 
the  number  of  units  sold  gives  the  total  expenses  for  the  period  and 
the  average  net  profit  per  unit  multiplied  by  the  number  of  units 
sold  gives  the  total  net  profit  for  the  period. 

These  statements  are  based  upon  the  fact  that  a  profit  is  not 
earned  upon  a  manufactured  article  until  the  article  is  placed  upon 
the  market  and  sold.  The  auditor  may  establish  his  calculations,  if 
he  so  desires,  upon  the  basis  of  units  of  production. 

PRESENTATION  OF  BALANCE  SHEET. 

The  preparation  of  the  balance  sheet  is  perhaps  the  most  im- 
portant duty  of  the  auditor  and  it  requires  a  practical  knowledge  of 

46 


the  science  of  accounting  to  exhibit  a  correct  statement  of  the  assets 
and  liabilities  of  a  business.  The  balance  sheet  is  a  statement  of  the 
actual  assets  and  liabilities  designed  to  show  the  true  financial  con- 
dition of  the  business  at  the  time  the  audit  is  completed.  The  follow- 
ing diagram  is  considered  very  good  form  for  a  balance  sheet  as  the 
assets  are  classified  under  the  headings,  Active,  Fixed  and  Passive 
and  the  liabilities  under  the  headings,  Floating,  Funded,  Capital  and 
Reserve : — 

ASSETS  LIABILITIES 

ACTIVE  FLOATING 

Cash  on  Hand  Accrued  Wages 

Cash  in  Bank  Accrued  Interest 

Accounts  Receivable  Accounts  Payable 

City  Ledger  Bills  Payable 

Wholesale  Ledger  FUNDFD 

Pennsylvania  Ledger 

Inventories  First  Mortgage  Bonds 

Coffee  Second  Moitgage  Bonds 

Ammonia  Debentures 

Sugar  CAPITAL 

BlueinS  Common  Stock 

FIXED  Preferred  Stock 

Real  Estate  Surplus 

Buildings  RESERVE 

Power  Equipment  Sinkinc-  Fund 
Horses  and  Wagons 

PASSIVE 

Suspense  Account 
Good  Will 
Franchises 
Patents 
Copyrights 
Promotion   Expense 

The  nature  of  the  assets  classified  under  each  of  the  three  sepa- 
rate and  distinct  headings  is  clearly  shown  by  the  diagram  and  does 
not  require  further  explanation  since  proper  attention  is  given  to 
this  subject  in  previous  instructions.  The  same  is  true  of  the  lia- 
bilities classified  under  each  of  the  four  separate  and  distinct  di- 
visions. As  a  matter  of  fact  the  auditor  incorporates  in  his  balance 
sheet  all  assets  and  liabilities  accounts  appearing  upon  the  general 
or  private  ledger  as  well  as  any  special  accounts  necessary  on  ac- 
count of  his  properly  handling  accrued  assets  or  floating  liabilities. 

The  intention  of  the  instructions  here  given  covering  the  details 
of  the  balance  sheet  is  to  present  an  outline  of  the  duty  of  the  audi- 
tor who  is  conscientious  and  painstaking  in  his  efforts  to  present  a 

47 


balance  sheet  absolutely  accurate.  It  is  true  that  many  auditors 
fully  aware  of  all  of  the  minor  considerations  essential  to  the  prep- 
aration of  a  comprehensive  balance  sheet  do  not  always  apply  this 
knowledge  to  their  best  ability,  but  are  negligent,  thus  making  their 
final  statement  incomplete. 

An  examination  of  the  assets  of  any  business  by  an  auditor 
should  be  thorough  and  comprehensive  enough  to  convince  him  be- 
yond all  reasonable  doubt  that  the  assets  included  in  the  balance 
sheet  are  worth  the  sum  at  which  they  are  valued.  In  other  words, 
he  should  exercise  reasonable  care  and  discretion  to  guard  against 
incorporating  in  his  statement  any  assets  at  inflated  values.  He  is 
not  expected  to  record  the  value  of  the  assets  from  the  standpoint 
of  how  much  they  would  bring  under  forced  sale  unless  he  is  audit- 
ing the  books  of  an  insolvent  business,  it  being  sufficient  for  him 
to  consider  their  value  from  the  standpoint  of  their  actual  cost  and 
their  worth  to  the  business  under  investigation.  He  is  expected  to 
see  that  proper  provision  is  made  for  the  depreciation  of  fixed  assets 
and  that  all  accounts  receivable,  known  to  be  uncollectible,  are  elim- 
inated from  the  statement.  It  is  sometimes  desirable  for  him  to 
establish  a  reserve  for  bad  and  doubtful  accounts. 

There  is  also  the  question  of  repairs  upon  which  there  is  a 
vast  difference  of  opinion  among  business  men,  manufacturers,  ac- 
countants and  auditors.  Some  regard  the  amount  expended  for  re- 
pairs as  a  capital  expenditure,  others  consider  that  this  item  should 
be  properly  charged  against  revenue  for  the  period  in  which  the  ex- 
penditure is  made. 

The  auditor  conducts  his  investigations  with  the  intention  of 
establishing  in  his  mind  absolute  certainty  as  to  whether  or  not  the 
nature  of  the  repairs  makes  them  capital  or  revenue  expenditure. 
The  auditor  should  see  that  all  assets  and  liabilities  of  the  business 
are  included  in  the  balance  sheet.  This  at  first  may  seem  an  un- 
necessary precaution,  although  proper  explanation  gives  it  consider- 
able importance.  Among  the  assets  for  which  many  business  houses 
carry  no  accounts  are  found  such  items  as  unearned  insurance,  ac- 
crued interest,  unexpired  taxes,  etc.,  among  the  liabilities,  accrued 
wages,  accrued  rent,  accrued  interest,  etc.  In  explanation  of  the 
floating  assets  reference  is  made  to  unearned  insurance  as  follows: 
If  a  corporation  pays  insurance  premiums  of  $3,000  upon  July  1st 
covering  policies  upon  their  plant  and  equipment  and  stock  for  the 

48 


f»n  QII it 


ensuing  twelve  months,  it  is  evident  that  if  the  audit  period  closes 
December  31st  following,  there  is  $1,500  of  unearned  insurance 
which  should  be  incorporated  in  the  balance  sheet  as  an  asset.  In- 
terest accrues  upon  the  interest  bearing  bills  receivable  held  by  the 
company.  Unexpired  taxes  are  included  for  the  amount  paid  in 
advance,  but  still  unearned. 

In  explaining  the  floating  liabilities:  If  the  audit  period  ends 
December  31st  which  happens  to  fall  upon  Wednesday  and  it  is  the 
policy  of  the  business  to  pay  their  employees  upon  Tuesday  of  each 
week  for  the  preceding  week's  work,  it  is  evident  that  at  the  time 
the  books  are  closed  there  is  accrued  three  days'  labor  for  the  entire 
business,  and  as  the  benefit  of  this  labor  expenditure  is  incorporated 
in  the  balance  sheet  by  an  increased  inventory,  manufactured  goods 
or  goods  in  the  process  of  manufacture,  there  should  be  a  corre- 
sponding liability  upon  the  credit  side  of  the  balance  sheet  as  the 
amount  is  not  paid.  Accrued  rent  is  not  taken  into  consideration 
except  in  cases  where  it  is  not  paid  in  advance.  Interest  accrues 
upon  borrowed  money  unless  paid  in  advance,  then  proper  adjust- 
ment is  made  for  unearned  interest,  which  is  an  asset. 

Another  item  frequently  of  vast  importance  which  deserves 
mention  in  the  final  report  consists  of  purchases  and  sales  discounts. 
Those  actually  taken  and  allowed  appear  in  the  trading  statement, 
but  those  which  are  expected  to  be  taken  and  allowed  do  not  appear 
upon  the  books.  A  corporation  purchasing  several  million  dollars 
of  material  annually  upon  a  cash  discount  basis  of  two  per  cent 
earns  a  considerable  sum  by  paying  their  bills  promptly.  Suppose 
that  during  the  last  ten  days  of  the  audit  period  purchase  invoices 
are  received  and  entered  upon  the  purchase  or  accounts  payable 
record  and  credited  to  the  accounts  payable  controlling  account 
amounting  to  $100,000,  their  discount  maturity  date  follows  the  date 
for  closing  the  audit.  It  is  evident  that  they  will  be  discounted  and 
that  as  a  result  the  business  will  earn  $2,000.  Perhaps  the  auditor 
is  not  justified  in  incorporating  this  profit  in  his  report  owing  to  any 
uncertainty  in  regard  to  the  payment  of  the  bills,  but  nothing  should 
prevent  his  making  comment  upon  it.  On  the  other  hand,  $100,000 
of  sales  may  have  been  made  during  the  last  ten  days  of  the  audit 
period  and  entered  upon  the  sales  ledgers  at  their  face  value,  whereas 
they  will  be  paid  and  discounted  during  the  ten  days  following  the 
date  the  audit  closes,  the  company  then  suffers  a  loss  of  $2,000. 

49 


At  first  it  may  seem  that  these  two  items  will  practically  offset 
each  other,  but  upon  further  consideration  it  must  be  admitted  that 
any  business  operating  at  a  profit  must  make  sales  greatly  in  excess 
of  its  purchases,  consequently  the  sales  discounts  taken  by  customers 
will  naturally  exceed  all  purchase  discounts  taken  by  the  business 
itself. 

A  CONDENSED  AUDITING  PROGRAM. 
The  Auditor's  Contract. 

Covers  specffic  details  of  the  audit,  amount  and  method  of  re- 
muneration, period  to  be  covered  by  the  audit,  nature  of  audit ; 
whether  complete,  pay-roll,  capital  stock,  reserve,  etc. 

Solicit  Valuable  Co-operation. 

Cultivate  acquaintance  of  individual  held  responsible  for  account- 
ing records  during  period  under  audit.  Ascertain  manner  of 
conducting  business  and  recording  transactions. 

Books  and  Records  for  Investigation. 

Ascertain  the  identity  and  purpose  of  all  records  of  original  en- 
try and  all  subsidiary  ledgers  and  records. 

Verify  Cash  Balance. 

Compare  actual  cash  on  hand  with  amount  which  cash  records 
show  not  yet  deposited,  that  is,  difference  between  cash  receipts 
and  deposits.  Compare  actual  amount  of  petty  cash  on  hand 
with  difference  between  original  fund  and  disbursements  prop- 
erly vouched  for. 

Verify  Bank  Balances. 

Secure  from  banks  with  whom  accounts  are  carried  certified 
statements  of  balances  on  deposit,  notes  discounted  or  deposited 
as  collateral,  and  any  contingent  liability  for  accommodation  en- 
dorsements, etc. 

Take  Trial  Balance. 

Take  trial  balance  from  general  or  private  ledger  or  verify  trial 
balance  already  taken. 

Check  and  Verify  all  Footings. 

Add  all  columns  in  special  columnar  account  books.  Foot  cash 
book,  check  register,  journal,  purchase  records,  sales  record  or 

50 


: 

rii^b. 


recapitulation,  bills  receivable  and  bills  payable  record,  etc.  -Note 
particularly  transfer  of  footings  carried  forward. 

Checking  Postings  of  Footings,  etc. 

Verify  all  postings  to  accounts  in  the  general  and  private  ledg- 
ers, both  debits  and  credits. 

Check  Trial  Balance  Previously  Taken. 

At  this  point  compare  balances  of  accounts  in  general  and  pri- 
vate ledger  with  balances  entered  upon  trial  balance. 

Check  Postings  of  Cash  Receipts. 

Check  in  detail  all  postings  from  cash  book  to  sectionalized  sales 
ledgers,  to  personal  accounts  in  general  and  private  ledgers,  etc., 
and  in  case  of  receipts  from  sale  of  stock,  to  accounts  in  stock- 
holders' ledger. 

Check  Postings  of  Cash  Disbursements. 

Check  in  detail  all  postings  from  cash  book  or  check  register  to 
purchase  or  accounts  payable  ledgers  where  accounts  with  cred- 
itors are  carried.  Also  check  all  postings  to  accounts  in  the 
general  or  private  ledgers.  Examine  and  check  voucher  register. 

Check  Purchases  Distribution. 

Examine  all  purchase  invoices,  compare  amounts  with  entries 
upon  purchase  record  or  voucher  register.  In  some  instances 
compare  invoices  with  original  quotations  or  purchase  orders. 
Verify  distribution  of  charges. 

Check  Postings  of  Purchases. 

Check  in  detail  all  postings  from  purchase  record  or  voucher 
register  to  accounts  payable,  credit. 

Take  Trial  Balance  of  Purchase  Ledger  Accounts. 

Total  credits  to  accounts  payable  for  purchases  made,  less  cash 
remittances  to  creditors,  discounts  earned  and  allowances  and 
rebates  of  whatever  nature,  gives  an  amount  which  should  agree 
with  balance  of  accounts  payable  controlling  account  in  general 
or  private  ledger. 

Check  Sales  Analysis. 

Examine'  all  sales  invoices,  check  against  shipping  record  to 
prevent  oversight  in  billing  shipments,  check  against  sales  record 
or  recapitulation  sheet.  Verify  sales  analysis  or  classification. 

51 


Check  Postings  of  Sales. 

Check  in  detail  all  postings  from  the  sales  records  or  recapitula- 
tion sheets  to  accounts  with  customers  in  the  sectionalized  sales 
ledgers,  debits. 

Take  Trial  Balance  of  Sales  Ledger  Accounts. 

Total  debits  to  accounts  receivable  for  sales  made  less  total 
credits  for  cash  remittances  received  from  customers,  discounts 
allowed  and  rebates  and  allowances  of  any  nature  gives  an 
amount  which  should  agree  with  the  balance  of  the  accounts- 
receivable  controlling  account  in  the  general  or  private  ledger.. 
Where  sectionalized  sales  ledgers  are  used  an  agreement  is  ef- 
fected between  the  items  therein  as  set  forth  above  and  the  bal- 
ance of  the  corresponding  controlling  account  in  the  general  or 
private  ledger. 

Check  Sales  Invoices  Against  Shipments. 

Examine  sales  invoices  and  check  against  acknowledgment  or 
confirmation  of  order  or  manifold  shipping  record. 

Take  Trial  Balances  of  Subsidiary  Ledgers. 

Effect  an  agreement  between  the  aggregate  balances  of  the  ac- 
counts in  each  subsidiary  ledger,  and  the  balance  of  the  corre- 
sponding controlling  account  in  the  general  or  private  ledger. 

Check  Inventory. 

Compare  pi  ices  with  purchases  invoices  covering  goods  and 
verify  extensions  and  additions.  Secure  certificate  of  assurance 
from  secretary  of  company  that  prices  are  correct. 

Check  Pay  Roll. 

Examine  last  pay-roll.  Check  time  clock  cards  and  piece  work- 
ers' receipts  against  entries  upon  pay-roll  and  verify  total.  Ef- 
fect an  agreement  between  total  labor  expenditure  and  pay-roll 
disbursement  properly  vouchered  by  clock  cards  and  receipts. 
If  labor  distribution  is  made,  verify  the  same. 

Check  Bills  Receivable. 

Examine  each  item  carefully  and  effect  an  agreement  between 
the  total  amount  of  bills  receivable  on  hand,  deposited  as  col- 
lateral security  or  otherwise  used  and  still  unpaid  and  the  bal- 
ance of  the  bills  receivable  controlling  account  in  the  general  or 
private  ledger. 

52 


Check  Bills  Payable. 

Examine  carefully  the  original  record  of  each  item  and  effect  an 
agreement  between  the  total  amount  of  all  bills  payable  issued 
and  still  unpaid  and  the  balance  of  the  bills  payable  controlling 
account  in  the  general  private  ledger. 

Presentation  of  Last  Office  Pay  Roll. 

Incorporate  in  final  report  a  copy  of  last  office  pay-roll.  Ascer- 
tain if  salaries  paid  to  officers  are  authorized  by  minutes  of  meet- 
ings of  Board  of  Directors. 

Take  Trial  Balance  from  Stock  Ledger. 

Effect  an  agreement  between  the  total  number  of  shares  issued 
and  outstanding  as  shown  by  debits  to  accounts  with  share- 
holders in  the  stock  ledger  and  the  total  number  of  shares  of 
authorized  capital  when  the  full  number  of  shares  are  subscribed 
and  issued.  If  there  is  any  treasury  stock  it  must  be  added  to 
the  total  debits  to  stockholders'  accounts  to  agree  with  total 
shares  of  capital  stock.  Examine  carefully  the  stock  certificate 
book.  Check  stubs  with  detached  certificates  against  entries  to 
accounts  with  shareholders  in  the  stock  ledger. 

Check  Dividend  Account. 

Make  list  of  all  dividends  declared  and  paid.  Ascertain  amount 
of  any  dividend  checks  outstanding  unpaid. 

Take  Trial  Balance  from  Private  Ledger. 

Ascertain  equilibrium  of  private  ledger  after  making  proper  al- 
lowance for  all  corrections  and  adjustments. 

Prepare  Trading  Statement. 

Present  statement  containing  all  trading  account  balances  and 
show  percentage  of  gross  profit  upon  net  sales  and  turnover. 
Present  departmental  or  classified  trading  statements  and  cor- 
responding percentages  when  opportunity  is  afforded  and  con- 
tract calls  for  them. 

Prepare  Profit  and  Loss  Statement. 

Present  statement  containing  all  profit  and  loss  balances  includ- 
ing gross  profits  from  trading  statement  entered  as  a  credit. 

53 


Show  net  profit,  establish  unit  of  production,  and  the  following 

statistics : — 

Total  output  in  units, 
Average  net  selling  price  per  unit, 
Average  operating  expense  per  unit, 
Total  average  cost  per  unit, 
Average  net  profit  per  unit. 

Prepare  Balance  Sheet. 

Present  statement  containing  all  assets  and  liabilities  accounts. 
Do  not  overlook  floating  assets  or  floating  liabilities.  Exercise 
proper  precaution  to  prevent  inflated  valuations.  Be  sure  all 
liabilities  are  included.  Consider  purchase  and  sales  discounts, 
depreciation,  reserves,  etc. 

Prepare  Schedule  of  Adjusting  Entries. 

Present  list  of  all  adjusting  entries  necessary  to  put  books  upon 
a  correct  basis.  Comment  upon  entries,  when  necessary,  that 
they  may  be  readily  understood.  Incorporate  in  final  report  any 
suggestions  for  improvement  in  methods  used,  etc. 

GENERAL  INFORMATION. 

After  having  carefully  studied  the  complete  audit  program  cov- 
ering all  of  the  important  and  minor  details  essential  to  the  success 
of  a  thorough  and  comprehensive  audit  and  carefully  reviewing  the 
condensed  audit  program,  it  may  occur  to  the  reader  that  there 
should  be  no  diversion  from  this  plan.  Notwithstanding  this  fact 
there  are  nearly  as  many  well  defined  plans  of  audit  as  there  are 
first  class  audit  companies  undertaking  the  work.  The  final  results 
are  approximately  the  same,  but  their  methods  of  getting  the  final 
results  differ  materially.  The  plan  selected  and  explained  is  consid- 
ered complete  and  comprehensive  and  it  is  safe  to  say  that  it  guar- 
antees accuracy  and  conservatism  which  make  the  auditor's  position 
very  secure.  It  is  a  plan  which  readily  meets  with  popular  favor 
because  it  is  easily  understood  and  its  thoroughness  particularly 
commends  it. 

It  is  an  excellent  policy  for  an  auditor  to  proceed  with  an  audit 
verifying  the  records,  etc.,  upon  a  monthly  basis  using  the  balances 
which  he  knows  to  be  correct  for  the  previous  month  in  connection 
with  the  entries  recorded  upon  the  books  in  the  succeeding  month, 

54 


for  the  purpose  of  arriving  at  the  balance  to  be  used  in  connection 
with  the  next  succeeding  month's  work,  etc.  If  the  audit  covers  a 
period  of  more  than  a  year,  or  a  period  of  years,  he  will  find  it  ad- 
vantageous to  present  monthly  comparative  statistical  reports. 

The  accounting  records  in  the  majority  of  business  houses 
claiming  even  mediocre  accounting  efficiency  are  now  simplified  to 
such  an  extent  that  satisfactory  results  are  obtained  by  the  use  of 
columnar  accounting  records  and  an  auditor  therefore  customarily 
uses  special  columnar  sheets  of  four,  six,  ten  and  fourteen  columns 
upon  which  to  make  notes  of  necessary  adjusting  entries,  etc.  His 
notes  entered  upon  these  sheets  as  the  errors  are  discovered  form 
the  basis  of  the  final  list  of  adjusting  entries  submitted  and  com- 
ments made  thereon. 

The  auditor  should  not  be  denied  access  to  the  record  of  min- 
utes of  the  corporation  for  meetings  of  both  stockholders  and  direct- 
ors, and  if  a  new  corporation  the  original  records  as  kept  by  the 
secretary  or  other  official  from  the  time  of  incorporation.  It  is  de- 
cidedly to  his  advantage  to  read  these  very  carefully  to  make  certain 
that  the  accounting  records  are  in  accord  with  all  votes  or  resolu- 
tions made  and  passed  by  the  stockholders  and  directors  as  regards 
salaries  of  officers,  etc.,  and  particularly  with  reference  to  the  au- 
thorized amount  of  capital  stock,  number  of  shares  and  the  values 
thereof.  This  suggestion  is  made  partially  for  the  reason  that  in 
many  instances  the  authorized  capital  stock  of  a  corporation  has 
been  not  more  than  one  thousand  shares  of  one  hundred  dollars 
each,  whereas  the  directors  have  sold  and  issued  stock  greatly  in  ex- 
cess of  the  authorized  capital  and  have  deliberately  misused  the  funds 
secured  from  the  selling  of  the  unauthorized  shares. 

It  is  regarded  as  good  form  for  the  auditor  to  incorporate  in  his 
final  report  a  detailed  analysis  of  each  account  carried  in  the  general 
or  private  ledger.  While  he  is  naturally  expected  to  present  proper 
statements  of  bills  receivable,  bills  payable,  copy  of  last  office  pay- 
roll; trial  balance,  trading  statement,  profit  and  loss  statement  and 
balance  sheet  of  accounts  in  the  private  ledger  and  in  some  instances 
he  does  not  regard  it  necessary  to  present  an  analysis  of  every  ac- 
count, in  view  of  the  nature  of  the  private  ledger  and  the  purpose 
it  is  intended  to  serve  it  is  recommended  that  a  proper  exhibit  of 
each  account  therein  be  incorporated  in  the  auditor's  report.  Partic- 
ular attention  should  be  paid  to  an  itemized  list  of  all  bad  debts 
having  any  bearing  whatever  upon  the  balance  sheet  or  any  suspense 

55 


accounts  included  at  their  face  value,  or  in  connection  with  which  a 
reserve  has  been  created. 

There  are  varying  conditions  to  be  dealt  with  in  different  lines 
of  business.  In  certain  lines  it  is  customary  to  enter  upon  the 
books  accounts  with  contracts  secured  prior  to  their  having  done  the 
work  called  for  by  the  agreements  set  forth  therein.  Such  an  oc- 
curence  should  not  escape  the  attention  of  the  auditor  who  should 
create  a  reserve  to  off-set  any  such  contract  accounts  equivalent  to 
the  estimated  cost  of  completing  the  work  which  must  necessarily 
be  performed  under  them.  The  same  is  true  in  some  lines  in  con- 
nection with  unfilled  orders.  It  is  reasonable  to  suppose  that  every 
business  man  has  a  perfectly  natural  desire  to  have  his  books  make 
as  good  a  showing  as  possible,  his  ambition  in  this  respect  some- 
times exceeds  proper  conservatism  and  he  unconsciously  includes 
among  his  assets  fictitious  items  such  as  unfilled  orders.  While  it 
is  true  that  a  good  bunch  of  orders  on  hand  possesses  a  certain 
amount  of  value  to  the  business,  it  is  also  true  that  there  must  be 
an  expenditure  in  time  and  money  to  complete  those  contracts  with 
the  possibility  of  some  of  them  being  cancelled  before  being  filled. 

An  adjustment  account  is  very  often  opened  in  the  general  or 
private  ledger  for  the  purpose  of  making  necessary  adjustments  and 
corrections  in  the  records. 

It  would  be  difficult  to  estimate  the  number  of  elective  auditors 
serving  some  of  the  best  corporations  who  are  absolutely  unqualified 
to  fulfill  the  responsibilities  intrusted  to  them  and  who  get  their 
monthly  trial  balances  by  deliberately  making  upon  the  books  a 
single  entry  equal  to  the  difference  between  the  debits  and  credits. 
Such  a  condition  is  deplorable  as  well  as  hard  to  account  for.  In  the 
first  place  a  person  cannot  understand  how  an  individual  can  delib- 
erately force  his  trial  balance  if  he  has  any  regard  whatever  for  the 
equilibrium  of  his  ledger.  There  is  reasonable  excuse  for  anyone 
making  errors  but  there  is  absolutely  no  excuse  for  a  person  to  de- 
liberately overlook  them  and  not  make  any  effort  to  find  them. 
There  is  so  much  literature  of  a  scientific  and  technical  nature  now 
published  covering  the  science  of  accounting  that  it  is  inexcuseable 
for  anyone  with  a  medium  amount  of  ambition  to  claim  a  lack  of 
knowledge  of  the  proper  methods  of  handling  the  work  which  in- 
variably reduces  the  situation  to  one  of  carelessness,  neglect  or  lack 
of  interest. 

56 


Check  marks  used  by  auditors  vary  materially,  although  each 
different  form  used  by  an  auditor  identifies  the  nature  of  his  investi- 
gation of  the  records  checked.  The  simplest  check  mark  is  commonly 
used  for  checking  postings  to  the  sectionalized  and  subsidiary  ledg- 
ers, while  the  double  check  mark  is  often  used  for  checking  postings 


COMMERCIAL  WORLD 
AUDIT  CO. 

EXAMINED 

AUG.I2.I9II. 

R.H.5PEAR. 

PRESIDENT. 


to  accounts  in  the  general  or  private  ledger.  The  permanent  auditor 
engaged  in  making  a  continuous  audit  customarily  uses  a  small  rub- 
ber stamp  for  each  day's  work  as  it  is  audited  and  verified  by  him. 
As  a  matter  of  fact,  the  science  of  accounting  is  reduced  to  certain 
general  principles  which  every  expert  bookkeeper,  accountant,  audi- 
tor, cost  accountant,  etc.,  should  be  thoroughly  acquainted  with.  In 
the  most  extensive  businesses  a  daily  trial  balance  or  proof  of  post- 
ings is  rapidly  becoming  the  demand  of  the  hour.  This  insures  a 
trial  balance  at  the  close  of  the  business  each  day,  at  the  end  of 
each  week,  each  month  or  in  fact  the  close  of  any  business  or  sta- 
tistical period. 

The  auditing  program  outlined  in  preceding  pages  is  recom- 
mended as  suitable  for  use  in  any  line  of  business,  although  the 
auditor  is  naturally  expected  to  exercise  his  best  judgment  under  all 
circumstances.  The  preceding  program  is  regarded  as  a  detailed 
complete  audit  and  is  recommended  in  preference  to  a  system  of  aud- 
iting by  totals,  as  explained  in  the  succeeding  pages.  The  system 
of  auditing,  later  described,  serves  excellently  the  purpose  for  which 
it  is  intended,  although  the  nature  of  some  businesses  prevents  its 
use  with  entire  satisfaction. 

SYSTEM  OF  AUDITING  BY  TOTALS. 

In  outlining  a  system  of  auditing  by  totals  it  is  for  the  purpose 
of  explaining  the  nature  of  the  audit  made  by  some  individuals  in 

57 


preference  to  a  complete  detailed  audit,  and  while  this  system  pos- 
sesses a  certain  amount  of  merit,  it  is  admitted  that  it  does  not 
provide  such  an  absolute  check  upon  the  work  as  will  satisfy  the 
majority  of  business  men  who  prefer  to  have  an  extensive  investi- 
gation made  of  their  accounting  records  when  an  audit  is  under  way. 

The  total  sales  for  the  period  is  used  as  a  basis  of  the  audit  and 
to  a  certain  extent  the  principles  involved  follow  very  closely  those 
already  outlined  in  connection  with  proof  of  postings  to  sectionalized 
sales  ledgers,  etc.  For  the  purpose  of  determining  the  total  amount 
of  sales  for  the  period  it  is  suggested  that  an  adding  machine  be 
used  taking  the  amount  of  each  invoice  from  the  manifold  invoice 
or  sales  record  or  recapitulation.  Anyone  familiar  with  the  princi- 
ples of  the  science  of  accounting  will  thoroughly  understand  the  fol- 
lowing explanations  made. 

The  principles  involved  apply  equally  as  well  whether  or  not 
sectionalized  sales  ledgers  are  used  as  the  total  sales  form  the  basis 
of  this  system.  The  auditor  first  determines  the  total  accounts  re- 
ceivable at  the  commencement  of  the  period  represented  by  the  net 
'debit  balance  of  the  accounts  in  the  sales  ledgers.  By  the  use  of  an 
adding  machine  he  readily  determines  the  total  sales  for  the  period, 
which,  of  course,  are  posted  to  the  debit  side  of  the  sales  ledger  ac- 
counts. In  addition  to  these  debit  postings  there  will  be  a  few  more 
from  the  journal,  these  are  also  determined.  Briefly  stated,  the 
total  accounts  receivable  at  the  commencement  of  the  period,  plus 
the  total  sales  for  the  period,  plus  the  total  debits  to  accounts  re- 
ceivable from  the  journal  for  the  period,  gives  the  total  debits  to 
the  sales  ledgers. 

The  next  step  is  a  consideration  of  the  credits  against  the  sum 
total  of  debits  explained.  For  this  purpose  the  total  accounts  re- 
ceivable at  the  end  of  the  period  is  regarded  as  an  inventory  and 
treated  as  a  credit.  There  will  be  a  few  other  credits  posted  from 
the  journal  which  will  have  to  be  verified.  The  auditor  then  adds 
the  journal  credits  to  the  accounts  receivable  inventory  at  the  end 
of  the  period,  and  deducts  the  amount  thus  obtained  from  the  total 
debits,  comprised  of  the  three  items  as  explained,  in  order  to  arrive 
at  the  postings  to  accounts  receivable  (credits)  from  the  cash  book, 
in  other  words,  net  cash  receipts  from  sales  accounts. 

The  majority  of  book-keepers  carry  at  least  two  columns  upon 
the  debit  side  of  their  cash  book,  one  is  used  for  the  amounts  of  all 

58 


general  cash  receipts,  the  other,  cash  receipts  from  sales  accounts. 
However,  if  general  cash  receipts  and  the  cash  receipts  from  sales 
accounts  are  both  entered  in  one  column,  then  the  auditor  is  com- 
pelled to  determine  the  total  cash  receipts  and  deduct  the  amount 
thus  obtained  from  the  total  cash  receipts  for  the  period  to  ascertain 
how  much  the  net  cash  receipts  from  sales  accounts  for  the  period 
should  be.  There  will  be  invariably  a  few  journal  entries  posted  to 
the  sales  division  of  the  ledger  which  makes  it  necessary  to  de- 
termine the  total  of  such  debits  and  credits.  It  is  admitted  that  the 
above  explanation  covers  in  a  measure  the  proof  of  the  postings  to 
the  sales  ledgers,  although  the  postings  of  items  comprising  the  gen- 
eral cash  receipts  are  not  proven.  These  should  be  totaled  and  the 
amount  compared  with  the  amount  of  total  general  cash  receipts 
shown. 

Up  to  this  point  the  auditor  has  endeavored  to  place  reasonable 
check  upon  cash  receipts  and  sales,  he  now  directs  his  attention  to 
the  credit  side  of  the  cash  book  or  check  register.  The  average  up- 
to-date  business  house  now  makes  all  disbursements  of  whatever 
nature  by  check,  with  the  exception  of  petty  cash,  for  which  a  check 
is  drawn  creating  the  fund.  Where  a  check  register  is  used  the 
amount  of  each  check  drawn  is  entered  in  a  special  column.  The 
same  is  true  if  the  cash  disbursements  by  check  are  entered  upon 
the  credit  side  of  the  cash  book.  In  undertaking  the  work  of  aud- 
iting the  cash  disbursements  the  auditor  does  not  rely  upon  the 
accuracy  of  the  amounts  entered  in  the  special  column  mentioned 
but  endeavors  to  place  a  check  against  this  record  by  referring  to 
the  bank  pass  book  which  shows  the  total  amounts  of  all  checks  re- 
turned by  the  bank  monthly  when  the  pass  book  is  balanced.  In  the 
first  place  he  determines  the  total  of  all  checks  returned  by  the  bank 
during  the  audit  period,  he  then  refers  to  the  stub  of  the  check  book 
at  the  commencement  of  the  period  for  the  purpose  of  determining 
the  total  amount  of  checks  outstanding  at  the  commencement  of  the 
period.  This  information  is  usually  set  forth  in  the  reconciliation  of 
the  check  book  and  pass  book  balances  as  entered  upon  the  check 
book  stub.  He  then  refers  to  the  check  book  stub  at  the  close  of 
the  period  and  determines  the  total  amount  of  checks  outstanding, 
in  the  same  manner.  If  the  book-keeper  has  not  already  reconciled 
the  check  book  and  bank  book  balances  the  auditor  may  do  so  him- 
self and  thus  be  certain  that  the  list  of  checks  outstanding  is  correct. 
This  explanation  makes  it  clearly  evident  that  the  total  amount  of 

59 


checks  returned  paid  by  the  bank  during  the  audit  period,  as  shown 
by  the  bank's  entry  upon  the  pass  book,  less  the  total  of  checks 
outstanding  unpaid  at  the  commencement  of  the  period,  plus  the 
total  amount  of  checks  outstanding  unpaid  at  the  close  of  the  period, 
gives  an  amount  which  should  agree  with  the  total  checks  issued 
as  recorded  in  the  cash  book,  or  upon  the  check  register  in  the 
special  column  showing  checks  drawn. 

It  is  rapidly  becoming  the  custom  among  up-to-date  business 
houses  to  demand  the  deposit  of  all  moneys  received  instead  of  ap- 
propriating cash  receipts  for  disbursements  of  any  nature.  If  this 
plan  is  followed  it  becomes  evident  that  the  total  deposits  for  the 
audit  period  should  agree  with  the  total  cash  receipts.  The  value  of 
this  plan  is  increased  by  noting  the  simplicity  of  the  following 
method  of  proving  cash  receipts  and  disbursements: 

The  auditor  refers  to  the  bank  pass  book,  which  when  balanced 
monthly  shows  the  monthly  totals  of  deposits  made  by  a  business. 
To  the  sum  of  the  monthly  totals  for  the  audit  period  is  added  the 
balance  on  deposit  as  shown  by  the  bank  pass  book,  and  from  the 
amount  thus  obtained  there  is  deducted  the  balance  on  deposit  at 
the  commencement  of  the  period  for  the  purpose  of  determining  the 
actual  deposits  made.  If  all  cash  receipts  are  deposited,  according 
to  the  prevailing  custom,  then  the  bank  deposits  shown  by  carrying 
out  the  above  plan  should  agree  with  the  total  cash  receipts  on  the 
debit  side  of  the  cash  book  for  the  sum  total  of  general  cash  receipts 
and  cash  receipts  from  sales  accounts. 

It  will,  therefore,  be  seen  that  under  this  plan  of  auditing  in 
which  sales  are  used  as  a  basis  the  total  cash  receipts  are  proven 
by  the  entries  upon  the  ledgers  and  the  total  cash  disbursements  are 
proven  by  the  bank  pass  book,  entries  in  which  are  made  by  the 
bank,  which  is  a  disinterested  party  from  an  auditing  standpoint. 

This  system  of  auditing  eliminates  the  necessity  of  adding  any 
of  the  columns  in  the  cash  book  or  check  register,  or  checking  the 
single  posting  to  any  of  the  accounts  in  the  ledgers.  It  is  consid- 
ered reasonable  proof  that  all  cash  receipts  have  been  properly  ac- 
counted for  and  as  the  audit  is  conducted  solely  by  totals  it  is  not 
a  laborious  task  for  the  auditor  to  check  the  monthly  footings  of 
special  columns  in  the  cash  book,  sales  records  or  journal  to  the 
controlling  accounts  in  the  general  or  private  ledger. 

The  actual  work  in  connection  with  this  system  of  auditing  con- 
sists in  adding  the  sales  for  the  period,  determining  the  amount  of 

60 


general  cash  receipts,  petty  cash  disbursements  are  taken  care  of  by 
drawing  a  check  for  creating  the  original  fund,  the  handling  of  the 
totals  indicated  according  to  the  plan  outlined,  proving  the  accuracy 
of  the  accounts  receivable  and  safe-guarding  against  inaccuracy  in 
any  of  the  general  accounts  in  the  trial  balance.  Aside  from  this 
work  the  auditor  is  expected  to  employ  the  usual  methods  for  as- 
certaining that  the  resources  of  the  business  as  entered  upon  the 
balance  sheet  are  not  inflated,  that  the  inventory  calculations  are 
correct  and  that  all  liabilities  of  the  business  are  included.  This 
system  does  not  guarantee  that  the  disbursements  have  been  made 
properly  to  cover  purchase  invoices,  etc.,  but  it  eliminates  the  neces- 
sity of  checking,  in  some  instances,  a  few  thousand  purchase  in- 
voices. It  disregards  purchase  distribution,  etc. 

A  careful  comparison  between  the  auditing  program  outlined  in 
the  preceding  pages  for  a  complete  detailed  audit,  and  this  system 
of  auditing  by  totals,  shows  a  considerable  discrepancy  in  the  latter. 
Jn  addition  to  there  being  no  verification  of  purchases  distribution,  as 
already  stated,  no  attention  is  given  to  the  stock  ledger  and  to  vari- 
ous other  considerations  essential  to  an  absolute  guarantee  that  the 
final  trial  balance,  trading  statement,  profit  and  loss  statement  and 
balance  sheet  presented  by  the  auditor  are  correct  and  exhibit  a  true 
condition  of  affairs  of  the  business.  It  is  designed  for  the  purpose 
of  proving  that  no  defalcation  has  occurred  in  the  handling  of  the 
cash. 


61 


Index 


Accountant   4 

Adjusting    Entries 42-43,  54 

Audit  Essential   7-9 

Auditing    3 

Auditor   5-6 

Auditors'   Certificates 13 

Contract   22,  50 

Duties    14 

Liabilities    15 

Qualifications   17 

Responsibilities    16 

Book-keeper   3 

Books  and  Records  for  Investigation 24,  50 

Condensed  Auditing  Program 50-54 

Co-operation   Sought 23,  50 

Cost   Accountant 7 

Different  Kinds  of  Audits 10 

Completed    Audit 11 

Continuous    Audit 11 

Partial    Audit 12 

Periodical  Audit 13 

Special   Audit 13 

Essential  of  an  Audit 18,  21 

Exhibit  of  Last  Office  Pay  Roll 40,  53 

General   Information 54-57 

Pay  Roll  Audit 37,  52 

Practical  Auditing  System 22 

62 


Statements : 

Balance    Sheet _  .,  .  .46-50,  54 

Bills  Payable 39,  53 

Bills    Receivable 39,  52 

Profit  and  Loss 45,53 

Trading   44,  53 

Systematizer 7 

System  of  Auditing  by  Totals 57-61 

Trial   Balance 27,50 

Private   Ledger 42,  53 

Purchase  Ledger  Accounts . .  33,  51 

Sales  Ledger  Accounts 35,  5'2 

Stock   Ledger 40,  53 

Subsidiary    Ledgers 36,  5'2 

Value  of  an  Audit 9-10 

Verifications: 

Bank  Balance 26,  50 

Cash    Balance 25,  50 

Dividend  Account 41,  53 

Footings    27,  50 

Inventory    , 36,  52 

Invoices  with  Shipments 35,  5'2 

Postings — Cash    Disbursements 30,  51 

Postings — Cash   Receipts 29,  51 

Postings — Purchase  Invoices 32,  51 

Postings — Sales   Invoices 34,  52 

Postings  to  Private  Ledger 27,  51 

Purchases    Distribution 31,51 

Trial   Balance 28,  51 

Sales   Classification 33,  51 


63 


UNIVEESITY  OF  CALIFOENIA  LIBKAEY 
BERKELEY 


DATE 


THIS  BOOK  IS  DUE  ON  THE  LAST 
STAMPED  BELOW 

Books  not  returned  on  time  are  subject  to  a  fine  of 
50c  per  volume  after  the  third  day  overdue,  increasing 
to  $1.00  per  volume  after  the  sixth  day.  Books  not  in 
demand  may  be  renewed  if  application  is  made  before 
.expiration  of  loan  period. 


DEC  18 


0,0 


SEP  11 1920 


50m- 7,' 16 


YC  24924 


2587^3 


